Chapter 27, Problem 1FRQ

a)

To determine

Federal reserve tools to address the recession.

Explanation of Solution

The three major tools that the Federal Reserve can use to address the nation are :

1. Interest rates: The Fed and other central banks throughout the globe employ short-term rate of interest manipulation as their primary instrument. Put simply, this strategy is increasing/decreasing interest rates to slow/boost economic growth and manage inflation.
2. Open market operations: Under this, the Fed buys or sells Treasury bonds throughout the open market. 
3. Reserve requirements: The number of reserves an institution must retain in relation to specific deposit obligations is determined by the reserve requirements, which are subject to adjustment by the Federal Reserve.

b)

To determine

Use of tools mentioned in part a by the federal reserve to increase the money supply.

Explanation of Solution

1. Interest rates: The fundamentals are fairly straightforward. By reducing interest rates, borrowing money gets more affordable, and saving money becomes less profitable, encouraging people and businesses to spend. As a result, savings drop as interest rates drop, more money is loaned, and more spending occurs. Additionally, the overall amount of money in the economy rises as borrowing levels do.
2. Open market operations: Because open market operations can change both interest rates as well as the overall money supply, it is comparable to directly influencing interest rates. Once more, this application's rationale is quite straightforward. When the Fed purchases bonds in the open market, it expands the amount of money accessible to the general public by exchanging the bonds for cash.
3. Reserve requirements: A portion of the authorized deposits must be held by the bank in vaults cash or deposits within Federal Reserve banks depending on the appropriate reserve ratio. The Fed can increase or decrease the amount these facilities can lend by changing the reserve ratios that are applied to depository institutions, which can further lead to an increase or decrease in the money supply.