major policy tools of the fed reserve system
MAJOR POLICY TOOLS OF THE FEDERAL RESERVE SYSTEM
-THE REQUIRED RESERVE RATIO -THE DISCOUNT RATE -CONDUCT OPEN MARKET OPERATIONS
Changing the required reserve ratio is used very rarely.
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The fed can lower the discount rate (or increase the penalty) to encourage loans
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The fed can raise the discount rate (or increase the penalty) to discourage loans
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CONTRACTIONARY MONETARY POLICY
INCREASE THE REQUIRED RESERVE RATIO This will cause more required reserves to be held Less money will be available to be loaned out. This will decrease the money supply.
EXPANSIONARY MONETARY POLICY
LOWER THE REQUIRED RESERVE RATIO This will free up excess reserves that can then be loaned out. This will increase the money supply.
THE FEDERAL FUNDS RATE
The interest a bank pays another bank for an overnight loan
Tool 2: THE DISCOUNT RATE/ interest rate on loans (penalty for violating the required reserve ratio)
The interest rate that banks pay to the Fed when banks need to borrow from the Fed. Assume a bank has loaned out too much money, or depositors suddenly withdrew money. Suddenly, the bank has less than the required amount of reserves. To get the REQUIRED amount of reserves, the bank can ask the Fed for an overnight loan.
Tool 1:THE REQUIRED RESERVE RATIO
The percentage of deposits that a bank must keep as reserves. The Fed can raise or lower the required reserve ratio. This affects the amount of money that banks are able to lend to the public.
