Tools of Monetary Policy

3 tools of monetary policy

• the reserve requirement

• only small amount of deposit is in the safe. Rest is loaned out "fractional reserve banking"
• F'ed sets the amount banks must hold
• The rr (reserve ratio)is the %  of deposits that banks must hold in reserve and not loan out
• When f'ed increases ms it increases amount of money held in bank deposits 

1. If in recession what should fed do to reserve requirement 

Decrease reserve ratio

• banks hold less money and have more excess reserves 
• Banks create more money by loaning out excess 
• Money supply increases, interest rates fall, AD goes up 

1. If in inflation what should fed to to reserve requirement

Increase reserve ratui

• banks hold more money and have less excess reserves
• Banks create less money 
• Money supply decreases, interest rates up, AD goes down

The discount rate

• the interest rate that the fed charges commercial banks

To increase the ms, the fed should decrease the discount rate( easy money policy)

To decrease the ms, the fed should increase the discount rate (contractionary policy)

Open market operations 

• the fed buys/ sells gov't bonds (securities) 
• Most important and widely used 

To increase the ms. The fed should buy gov't securities

To decrease the ms, the fed should sell gov't securities 

Federal funds rate is where FDIC meme we banks loan each other overnight funds 

Prime rate the interest rate banks charge their most credit worthy customers