...The Federal Reserve controls the economy of the United States through a variety of tools. They use these tools to shape the monetary policy of the United States in order to promote economic growth and reduce the rate of inflation and the unemployment rate. By adjusting these tools, the Fed can control the amount of money in the supply. By controlling the amount of money, the Fed can affect the macro-economic indicators and steer the economy away from runaway inflation or a recession. The Federal Reserve The Federal Reserve uses three main tools in order to control the money supply. The first tool is open-market operations. These operations consist of the buying and selling of government bonds to commercial banks and the public. Open-market operations are the most important tool that the Fed can use to influence the money supply (Brue, 2004, p. 252). By buying bonds from the open market, the Federal Reserve increases the reserves of commercial banks that in turn will increase the overall money supply in the country. The opposite is true if the Fed sells bonds on the open market. By doing so, the Fed reduces the reserves of banks and, in turn, takes money out of the system. By being able to control how much money the commercial banks can lend, the Fed has a very powerful tool to adjust the economy. The second tool in the Federal Reserve’s arsenal is the adjustments of reserves ratio. The reserves ratio is the required amount in which a bank must have at all times. By raising...
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...variety of tools. They use these tools to shape the monetary policy of the United States in order to promote economic growth and reduce the rate of inflation and the unemployment rate. By adjusting these tools, the Fed is able to control the amount of money in the supply. By controlling the amount of money, the Fed can affect the macro-economic indicators and steer the economy away from runaway inflation or a recession. The Federal Reserve uses three main tools in order to control the money supply. The first tool is open-market operations. These operations consist of the buying and selling of government bonds to commercial banks and the public. Open-market operations are the most important tool that the Fed can use to influence the money supply (Brue). By buying bonds from the open market, the Federal Reserve increases the reserves of commercial banks which in turn will increase the overall money supply in the country. The opposite is true if the Fed sells bonds on the open market. By doing so, the Fed reduces the reserves of banks and, in turn, takes money out of the system. By being able to control how much money the commercial banks can lend, the Fed has a very powerful tool to adjust the economy. The second tool the Federal Reserve uses is the adjustment of the reserve ratio. The reserve ratio is the ratio of the required reserves the commercial bank must keep to the bank’s own outstanding checkable-deposit liabilities (Brue). By raising and lowering the ratio, the Fed can control...
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...favoring use of both policies, but most of the time, only one is necessary. Fiscal Policy can be explained in many ways, for example. Fiscal policy is the use of the government budget to affect an economy. When the government decides on the taxes that it collects, the transfer payments it gives out, or the goods and services that it purchases, it is engaging in fiscal policy. The primary economic impact of any change in the government budget is felt by particular groups make tax cut for families with children, for example, raises the disposable income of such families. Discussions of fiscal policy, however, usually focus on the effect of changes in the government budget on the overall economy on such macroeconomic variables as GNP and unemployment and inflation. Fiscal Policy also can be explained as the economic term which describes the behavior of governments in raising money to fund current spending and investment for collective social purposes and for transfer payments to citizens and residents of the territory for which the government is responsible. The money may be raised by taxation, by borrowing, by user charges on social assets or services, or by fiat. Fiscal policy can include deficit spending to stimulate demand for domestic goods and services to help unemployment or make efforts to cut deficits or raise the budget surplus to fight inflation. There are many different types of Fiscal Policy. It all depends on the given situations the government is in. A government...
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...Winston Edmonston-Deigh Money and Banking-ECO320 February 1, 2011 Describe the Federal Reserve’s assessment of the current economic activity and financial markets. According to the staff review of the Federal Reserve, consumer spending increased significantly in 2010. Private investment in the form of business outlays for equipment and software is showing a sustainable growth. Construction activities, on the other hand, in both residential and nonresidential sectors of the construction industry are weak. The Fed’s staff observes that the industrial production increased solidly in the recent months due to the colder weather boosting the activities in the utilities. Even though there is a modest gain in employment, unemployment remained high. The trade deficit narrowed slightly in the last months of 2010 due to the increase in agricultural goods exports. The rise in imports was due to the increases in the value of the petroleum products. In the imports front, the Fed observes that the imports of automotive products, services, and consumer goods declined significantly. The Fed expects that the trade deficit will improve over the coming months. In the financial markets front, the Fed observes that short-term funding markets sustained their stability. As for then capital markets, broad U.S. stock price indexes increased. In fact, bank stock prices increased significantly. The corporations started issuing bonds. However, the Fed observes that debt financing...
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...The Three Main Tools of Monetary Policy 1. How would the Fed use the three monetary policy tools to pursue an expansionary policy and a contractionary policy? Monetary Tool Expansionary Policy Contractionary Policy Open Market Operations Discount Rate Reserve Requirement________________________________________ 2. Circle the correct symbol (⇑ for increase or ⇓ for decrease). What would happen to the money supply and interest rates if the Fed… a. purchased government securities on the open market? Money Supply ⇑ ⇓ Interest Rates ⇑ ⇓ b. raised the discount rate? Money Supply ⇑ ⇓ Interest Rates ⇑ ⇓ c. lowered the reserve requirement? Money Supply ⇑ ⇓ Interest Rates ⇑ ⇓ 3. With an easy money policy (expansionary monetary policy), the equilibrium supply of money(increase/decrease) while interest rates ________________. The (higher/lower) interest rates should cause investment expenditures to __________, this change in investment spending will cause Aggregate Demand to (increase/decrease). Therefore, an easy money policy is consequently appropriate for countering a(an) _______________ gap. 4. If a bank received a deposit of $10,000 when the reserve requirement is 25%,how much… a) will it hold as required reserve? __________ b) will it have in excess reserves? __________ c) is the money multiplier? __________ d) will total deposits in the entire banking system rise? __________ e) new money will be created...
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...the committee is expected to make decisions on the continuity of its asset repurchase program and the federal funds rate. Fed Chair Yellen should present the fact that in Q3, the economy has continued to grow at 4% rate. And that unemployment rate has dropped to a low 5.9%. These positive signals indicate a healthy economy moving towards maximum employment and price stability. Chair Yellen should first confirm that the current $5 billion asset repurchase program will end by the end of the year. And second, should present the expected economic progress and determine for how long ZIRP will be maintained. It is also important for Chair Yellen to discuss how the Fed is going to protect the economy from future potential recessions especially by discussing these three points: 1. Progress report on the Dodd-Frank act, how to expedite and simply the rulemaking process. 1. TBTF banks are a risk to financial stability. A plan must be put in place to decrease their size so that failure becomes an acceptable option. 2. The Fed should move towards a data-driven organization. Using the Taylor rule to set its federal funds rate will remove any second guessing. 1. What is the current economic situation and how did we get here? Give your policy recommendation with some detail, including ideas on the timing and details of normalizing policy, including exit tools. The U.S. economy is recovering from the deepest recession since the Great Depression in the 1930s. The financial crisis...
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...Ch a p ter 17 Tools of Monetary Policy In the chapters describing the structure of the Federal Reserve System and the money supply process, we mentioned three policy tools that the Fed can use to manipulate the money supply and interest rates: open market operations, which affect the quantity of reserves and the monetary base; changes in discount lending, which affect the monetary base; and changes in reserve requirements, which affect the money multiplier. Because the Fed’s use of these policy tools has such an important impact on interest rates and economic activity, it is important to understand how the Fed wields them in practice and how relatively useful each tool is. In recent years, the Federal Reserve has increased its focus on the federal funds rate (the interest rate on overnight loans of reserves from one bank to another) as the primary indicator of the stance of monetary policy. Since February 1994, the Fed announces a federal funds rate target at each FOMC meeting, an announcement that is watched closely by market participants because it affects interest rates throughout the economy. Thus, to fully understand how the Fed’s tools are used in the conduct of monetary policy, we must understand not only their effect on the money supply, but their direct effects on the federal funds rate as well. The chapter thus begins with a supply-and-demand analysis of the market for reserves to explain how the Fed’s settings for the three tools of monetary policy determine...
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...Federal Reserve Control the Money Supply? Federal Reserve or simply “the Fed” is an independent entity whose main goal is to provide the nation with a safer, more flexible, and more stable monetary and financial system. It is the central bank of the United States that influences the monetary policy by controlling the money supply and cost of money in able to give the economy full employment, low inflation rate, and stable prices. Manipulating money supply is a very powerful tool use by the Fed to stabilize the economy. So how does the Federal Reserve control the money supply? The Fed uses three different methods to increase or decrease the amount of money supply in the economy. The first method is by conducting open market operations, which affects the federal funds rate. In open-market operations, the Fed buys and sells government securities in the open market. If the Fed wants to increase the money supply, it buys government bonds. This supplies the securities dealers who sell the bonds with cash, increasing the overall money supply. Conversely, if the Fed wants to decrease the money supply, it sells bonds from its account, thus taking in cash and removing money from the economic system. Open-market operations are the most important tool that the Fed can use to influence the money supply. Perfect example was during the recession of 2007 – 2009. The primary tool that the Fed used early during the current crisis was to cut the Federal Funds rate. The Fed initially conducts open...
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...Writer’s Name Instructor’s Name Course Date Economics Federal Reserve System Federal Reserve System or FED is basically a central banking system of USA that created on December 1913, due to severe financial conditions. Now this is playing different functions for boosting the USA economy those are: * Working as a central bank for United States * Address about the financial severe problems * Regulates and instruct the other banking systems * Control monetary policy through manage the money supply in the economy * Provide the financial facilities to other financial institutions, US government to strengthen the economy of US * Provide the major facility of exchange of payments in the different regions. * It also play a role in maximizing employment, stability of price level as well as long term moderate interest rate in the economy. * Open market operations in which selling and purchasing of government securities occurs by the FED. These operations are in the control on the FOMC. So it basically plays a role in providing largest payment system in the world. Every day many transactions occur between the different sellers and purchasers of goods in term of US dollar. It also maintains millions of accounts as well as performing a role in settling and clearing different financial institution payments through intermediaries. FED play a vital role in providing the facility of financial services to depository institutions like distributing currency...
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...affects the supply of money and decisions made by banks on borrowing. I will explain the Monetary Policy used by the Fed to control the supply of money and how these aim to avoid inflation. I will explain how the infusion of stimulus programs affects the supply of money. I will also describe the current indicators that show there is too little or too much money in the economy today and what steps are being taken to correct this. The current state of the economy and the demand for money are factors that influence the Federal Reserve to adjust the discount rate. Banks request additional money when their reserves get low. Changes in real estate become a factor when homeowners are unable to pay their mortgages and banks lose money. The Federal Reserve decreased interest rates for the real estate market, which made it less expensive for banks to borrow funds. “A change in the credit supply and demand influenced the Federal Reserve to increase the discount rate, discouraging banks from requesting money by making it more expensive for banks to borrow funds, (Colander, 2010)”. The Feds use the spread between the Discount Rate and the Federal Funds Rate to increase or decrease the supply of money. If the Discount Rate is lower than the Federal Funds Rate, banks will borrow from other bank which does not increase the supply of money. When the Federal Funds Rate is lower than the Discount Rate, banks will borrow from the Federal Funds which increases the supply of money. The discount...
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...target, then the Fed should raise the real Federal funds rate by one-half a percentage point. growth in the money supply should be limited to the long-run average growth rate of real GDP. the rate of money growth should be set at 4 percent per year. for every 1 percentage point that unemployment exceeds the natural rate of unemployment, there is a 2 percentage point gap between potential and actual GDP. The demand for Federal funds is upsloping. downsloping. vertical. horizontal. Generally, the prime interest rate: is highly inflexible downward. remains constant over long periods of time. moves in the same direction as the Federal funds rate. moves in the opposite direction as the Federal funds rate. Which of the following statements is correct? Interest rates and bond prices vary directly. Interest rates and bond prices vary directly during inflations and inversely during recessions. Interest rates and bond prices are unrelated. Interest rates and bond prices vary inversely. (Last Word) Other things equal, a restrictive monetary policy during a period of demand-pull inflation will: increase productivity, aggregate supply, and real output. increase the interest rate, reduce investment, and reduce aggregate demand. lower the price level, increase investment, and increase aggregate demand. lower the interest rate, increase investment, and reduce net exports. (Consider This) The Fed is like a sponge...
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...through its ability to issue money. Open your wallet or your purse and take a look at some bills. At the top, you will see the words “Federal Reserve Note.” In the past, many banks issued their own bank notes, which were used as money. But today the money we use in the United States is provided by just one bank, the Federal Reserve. Thus, the Federal Reserve has the power to create money—an awesome power that forms the centerpiece of this chapter. The Fed doesn’t have to literally print money. It can, as we shall see in more depth later in this chapter, also create money “by computer” by adding reserves to bank accounts held at the Fed. This new money can be given away or lent out in a way that increases aggregate demand. If the Federal Reserve is a bank, who are its customers? The Fed is both the government’s bank and the banker’s bank. As the government’s bank, the Fed maintains the bank account of the U.S. Treasury. When you write a check to the IRS to pay your taxes, the money ends up in the Treasury’s account at the Fed. In addition to receiving money, the U.S. Treasury also borrows a lot of money and the Fed manages this borrowing—that is, the Fed manages the issuing, transferring, and redeeming of U.S. Treasury bonds, bills, and notes. Since the U.S. Treasury is by far the world’s largest bank customer—it has more income and it also borrows more than any other bank customer—the Federal Reserve is a large and powerful bank. In addition, the Fed is also the banker’s bank....
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...PTER 16 Tools of Monetary Policy Roadmap 2 Market for reserves and federal funds rate Demand and Supply (Partial) Equilibrium Comparative Static Analysis Introduction to monetary policy tools Conventional tools Unconventional tools Hyung Sun Choi, Kyung Hee University Market For Reserves & Federal Funds Rate 3 Demand and Supply in the Market for Reserves What happens to the quantity of reserves demanded by banks, holding everything else constant, as the federal funds rate changes? Fed Funds Rate: the interest rate on overnight loans of reserves from one bank to another. The primary instrument of monetary policy Hyung Sun Choi, Kyung Hee University Demand for Reserves, 4 d R Rd = required reserves + excess reserves Since the fall of 2008 the Fed has paid interest on reserves at a level set at a fixed amount below the federal funds rate target. Excess reserves are insurance against deposit outflows The cost of holding these is the interest rate that could have been earned minus the interest rate on reserves, ior Hyung Sun Choi, Kyung Hee University When the federal funds rate is above ior as the federal funds rate decreases, the opportunity cost of holding excess reserves falls and the quantity of reserves demanded rises Downward sloping demand curve that becomes flat (infinitely elastic) at ior 5 Hyung Sun Choi, Kyung Hee University Supply in the Market for...
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...Introduction Monetary policies suggest greater attention over the world by renewed the interest in employing the central banks to control the money supply. Role of monetary policy is important to maintain a low and stable rate of inflation and price stability in the economy.(Rangarajan,1998) Imbalances of the import and export can cause the fluctuation of the exchange rate in the country. Different central bank used different monetary tools to control the money supply and maintain the economic stability of the country. Monetary Tools Used to Control the Money Supply 1. Bank of England (BoE) BoE used operational standing facilities (OSF) and interest rate (IR) to control the money supply in the countries. OSF is used to provide a security value for the market liquidity management and provides an arbitrage instruments in a standard market condition to make sure the IR will be in line with the Bank Rate. OSF gives bank resources to manage unexpected frictional payments shocks that could take the reserves accounting below zero.(Red Book-BoE,2010) IR is used to control the inflation rate by injecting money directly into the British economy by purchasing the government bonds and high quality corporate bonds. Reduction in bank IR cause borrowing more attractive and saving less attractive, this will affects the spending by companies and their customers over time the rate of inflation.(Niklov,2002) IR will cause the increase in exchange rates in Sterling relative to overseas...
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...effort to stabilize the fluctuating economy. More specifically, the government has used expansionary fiscal and monetary policies to do so. Such fiscal policies used affected the taxes and government sending both positively and negatively as well as aggregate demand, GDP, and employment, while the monetary policies applied have adjusted the required reserve ratio and discount rates and have resulted in the purchasing and selling of government securities. In a developed country such as ours, fiscal policy is an important tool used to steady the economy. In terms of using this tool as an aid to expansion, necessary adjustments in taxes and government spending are required, resulting in changes in aggregate demand, GDP, and employment. “Fiscal policy is an important tool for managing the economy by having the ability to affect the total amount of output produced,” aggregate demand, and employment (Buena-Bontas & Petre , 2009). How is this done? These changes are made through adjustments in taxes and government spending. In most cases adjustments in tax rates and government spending work concurrently. During a time of high deficit and debt, it is in the government’s best fiscal interest to raise tax rates to create more revenue, and to cut spending to save what they have. “Fiscal policy is mainly directed at shifting aggregate demand…the goal is an equilibrium level of national income that generates full employment with price stability” (Amacher & Jennifer, 2012). In order...
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