Question

What are the three main tools the Federal Reserve (Fed) has at its disposal to carry out monetary policy? setting the discount rate, increasing taxes, and building highways conducting open market operations, increasing spending by the federal government, and decreasing taxes conducting open market operations, setting the discount rate, and paying interest on reserves O paying interest on reserves, conducting open market operations, and controlling money demand During the financial crisis of 2007-2008, the Fed engaged in lending to certain large non-bank financial firms in the private sector. Which of the statements describes the reasoning behind the Fed's decision to engage in this type of nontraditional lending? The Fed wanted to make a higher than normal return on their investment. The Fed wanted to limit the systemic risk inherent among financial institutions. The Fed wanted to limit the inflation risk inherent among financial institutions. The Fed wanted to limit the interest rate risk inherent among financial institutions.

Answer 1

Answer 1: The correct option for the three main tools of Federal Reserves are : Open market operations, setting discount rate and paying interest on reserves.

The Federal reserves can participate in open market operations in which it buys and sells bonds in the open market which can be used to control money supply. It sets the discount rate, which helps to control money supply in the country. High discount rate means low money supply and vice versa. It also pays interest on reserves which are parked by the commercial banks in the Federal reserves. If it pays high interest on reserves of the commercial banks, there will be more money supply in the economy.

Other options are wrong because:

Charging taxes, building highways comes under government's fiscal policy. Further, it cannot control money demand, it can control money supply because money is demanded by public and money is supplied by the central bank.