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What Are the Tools Used to by the Federal Reserve to Control Money Supply?

Essay by   •  May 16, 2011  •  Term Paper  •  303 Words (2 Pages)  •  1,201 Views

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What are the tools used to by the Federal Reserve to control money supply?

The stimulation takes us through how the Federal Reserve uses different channels to affect the money supply and what affect it has on the economy. There are 3 things the fed use to control the money supply, the Discount Rate and the Federal Funds rate. The discount rate is what the Federal Reserve charges banks. Lending money to banks or thrifts this interest rate is called a discount rate. The Federal Reserve will lend money to U.S. banks as a last resort. (Economic 2005) If the banks see the Federal Fund rate which is charged by other banks is lower than the discount rate they will borrow from other banks. This will have no effect on the money supply. The bank is required to hold what they call a required reserve ration. They must put in the Federal Reserve or hold in their vault a percentage of their checkable deposits. This is required so if a for some reason everyone that has money in the bank would come and get their money out of the bank they will be able to support this. This is another way that Federal Reserves how many loans the bank can offer because we could put too much money in the economy this may cause inflation and decrease the value of the dollar. Lastly Open Markets are the most important instrument used by the Federal Reserve to control the money supply. When Federal Reserve banks buy government bonds from the commercial banks it takes part of the banks government bonds and when the Federal Reserve pay for these securities it increases the reserves of the bank by the amount of purchase. (Economic 2005)

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