If you were in a discussion about The Federal Reserve System about the tools the
ID: 1223940 • Letter: I
Question
If you were in a discussion about The Federal Reserve System about the tools they use to pursue montery policy and what tool they use the most how would you comment or reply to the follow the statement is it right, wrong the correct use by FED and so on.
The Federal Reserve System is sanctioned to ensure that there is enough money, as well as credit, in the funding system that is needed to upkeep a budding economy. The Federal Reserve System also has the power to buy (and sell) government securities in order to lend to associate banks and to require that associate banks hold a reserve obligation equivalent to a percentage of their bond. Steady interest rates, firm financial markets, economic development, and constant exchange rates are just a few of the goals set forth by the Federal Reserve System. The Fed purchases and sells government securities, sets the reduced rate, & sets permissible reserve requirements for associate banks. The open market is the tool that is most commonly used by the Federal Reserve
Explanation / Answer
The above statements are right as the Federal Reserve System controls the supply of money in an economy. It has various tools to control it like open market operation, reserve requirement, federal funds rate, etc. Open market operation is the purchase and sale of government securities by the Federal Reserve System. When Fed sell government securities then it sucks money from the economy and reduces the money supply while purchase of government securities injects new money into the system. Secondly, every bank has to maintain a fixed deposit of their depositors with the Fed in the form of reserves which is called reserve requirement. Increase or decrease of reserve requirement decreases or increases the money supply in the economy. Federal funds rate is the rate which is charged by one bank from another for overnight loan provision. This rate is set by the Federal Reserve. Increase in this rate decreases the money supply and vice-versa. Open market operation is a tool which is mostly used by the Federal Reserve to control the money supply.