Tools Used By the Fed to Implement Monetary Policy

Reserves greater than the required amounts are known as

excess reserves

This tool, __________________, is very disruptive to bank operations.

Adjusting Reserve Requirements

________________________ encourages banks to lend more of their reserves since they can easily loan money from the Fed at a reduced discount rate.

Adjusting the discount rate

Monetary policy that increases the money supply is

easy money policy

The tool used most often by the Fed is ______________.

open market operations

The rate of interest banks charge on short-term loans to the best customer is the

prime rate

Adjusting the Discount Rate

The discount rate is the interest rate that the Fed charges on loans made to other banks. If the Fed wants to increase money in circulation it might reduce the discount rate. This will encourage banks to lend more of their reserves since they can more easily borrow money from the Fed at a reduced discount rate to maintain the required reserve amount. Increasing the discount rate will discourage banks from lending their reserves because the banks will not wish to borrow money from the Fed at the higher interest rate in order to maintain the reserve requirement.

If a bank borrows money from another bank, the bank charges this type of interest rate.

federal funds rate

A delay in implementing monetary policy is known as a/an

inside lag

By ____________ a portion of your funds to others, the banks can put more money into the ____________.

loaning; economy

The belief that the money supply is the most important factor in macroeconomic performance is

monetarism

If the FOMC wishes to decrease the level of money in circulation, it ________________________.

sells bonds back to the bond sellers

How Monetary Policy Operates:

1. monetary policies adjusts the amount of money in circulation 2. interest rates are affected by the amount of money in circulation 3. the amount of money spent and invested in the economy is influenced by interest rates

Will the Fed increase or reduce the money supply in the following situations: (1) economy is in a fast rate of expansion (2) business cycle is in a contraction?

The Fed will (1) reduce money supply when the economy is in a fast rate of expansion and (2) increase money supply when the business cycle is in a contraction.

Open Market Operations

The most widely used tool by the Fed is open market operations, which refers to the purchasing and selling of government securities (bonds) to adjust the money supply. If the Federal Open Market Committee (FOMC) wishes to increase the amount of money in circulation, it will authorize the Federal Reserve Bank of New York to buy government securities on the open market. The bond seller takes the money paid to them by the FOMC and deposits it in their bank, which increases money in the money supply. If the FOMC wishes to decrease the level of money in circulation, it sells bonds back to the bond sellers. This money is deposited by the Fed in its own reserves and the money is out of circulation.

Adjusting Reserve Requirements

The portion of deposits that banks are required to keep on hand is called the Required Reserve Ratio (RRR). The Fed can adjust the rate of this ratio whenever it wants to reduce or add money to the money supply. Lowering the RRR will free up more money for banks to loan, which would increase the money being circulated in the economy. Increasing the RRR will mean less money the banks can loan out since more must be kept in reserve. Thus, money is taken out of the economy. This tool is rarely used because it is very disruptive to bank operations.