Answered: These questions involve the Federal…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

See similar textbooks

Related questions

Question

These questions involve the Federal Reserve’s monetary policy tools.
a. Imagine that the FOMC suddenly discovers that it needs to drastically cut the amount of M1 in the country in a very short amount of time. Which of the three tools would you suggest they use, how, and why?
b. Now suppose that the FOMC determines that the cut doesn’t need to be that drastic, and the window of time is significantly longer than originally thought. Which of the three tools would you suggest they use, how, and why?

Expert Solution

Step 1

The FOMC is the Federal Open Market Committee which is the committee which determines whether to increase or decrease the money supply in the economy. When it determines to reduce the money supply, it makes use of the three monetary policy tools which are as follows:

The discount rate: The discount rate is the interest rate charged by the central bank on the loan provided by the central bank to the commercial banks. When there is recession, there will be no more money present in the economy. In this situation, the Fed will increase the discount rate. As the discount rate increases, it will result in the higher cost of borrowing from Fed. Thus, the borrowings from the central bank will decline and that means the commercial banks will be encouraged to take more loan from Fed and this will increase the money supply. Thus, in order to control and fight against the inflation, the fed should go for reducing the discount rate.

Reserve requirement rate: The reserve requirement ratio is the ratio of the money that the commercial banks have to hold in the form of cash and gold. When there is reduction in the reserve requirement ratio, there will be more money in the valet of the consumer which increases the money supply in the economy. Thus, when the economy faces recession, the RRR would be declined and vice versa which increases the money supply and vice versa.

Open market operations: The Fed sells the government securities and bonds when there is inflation in the economy. Thus, people who buy the securities will pay the US central bank which helps to reduce the supply of money of the economy. When there is recession in the economy, the Fed will go for the purchase of the government bonds and securities which helps to release new money into the market to facilitate the growth in the money supply and vice versa.

Step by step

Solved in 2 steps

Knowledge Booster

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.

Similar questions