Question

In seven to ten sentences, discuss the three tools of Fed's Monetary Policy. Provide examples as needed.

Answer 1

As the country’s monetary authority, the Fed implements monetary policy for the purpose of promoting stable economic growth by influencing the availability and cost of money and credit. The dual mandatory goals of monetary policy are maximum growth and stable prices. To achieve these goals, Fed uses the monetary tools like open market operation, Discount rate and Reserve requirements. The Open Market Operation is the buying and selling of government securities in the open market. The purpose is to stabilize the credit flow in the economy. Discount rate is the rate charged by the Fed when the financial institution borrows through the discount window in emergencies. Reserve requirement is the statutory fixed minimum reserve that all financial institutions required to keep as reserve.

By using these three monetary tools Fed controls the flow of money and credit in the nation. During times of inflation the Fed sells government securities in the open market which reduce the availability of money in the economy. During times of recession the Fed buys these securities in order to enlarge the money supply. By rising and lowering the discount rate and reserve ratio the Fed controls the money supply and thereby stabilizes the economy.