5.2 Monetary Policy
Learning Target 24. Explain how the Federal Reserve System uses monetary tools to regulate the nation’s money supply and moderate the effects of expansion and contraction in the economy.
Monetary tools employed by the Federal Reserve System to regulate the nation’s money supply include:
Purchasing government securities, reducing the discount rate, and reducing the reserve requirement all serve to increase the money supply, decrease interest rates, encourage consumer and business spending, and foster economic expansion.
Selling government securities, increasing the discount rate and increasing the reserve requirement all serve to reduce the money supply, increase interest rates, depress consumer and business spending, and foster economic contraction.
- Open market operations (purchase and sale of government securities);
- Adjusting the discount rate (interest rate on loans the Fed makes to financial institutions); and
- Adjusting the reserve requirement (required reserve ratio – the fraction of deposits that banks must keep on reserve and not use to make
Purchasing government securities, reducing the discount rate, and reducing the reserve requirement all serve to increase the money supply, decrease interest rates, encourage consumer and business spending, and foster economic expansion.
Selling government securities, increasing the discount rate and increasing the reserve requirement all serve to reduce the money supply, increase interest rates, depress consumer and business spending, and foster economic contraction.