Question

Explain how the Federal Reserve Board can increase or decrease the money supply using each of the following tools: reserve requirements, open-market activities, and discount rates

Answer 1

Answer:

Reserve requirements – Reserve requirement increases to decrease the money supply or vice versa.

Open-market activities – the Fed sell the securities to reduce money supply or purchase it to increase the money supply.

Discount rates – Decrease the discount rate to increase the money supply or vice versa.

Explanation:

The Federal Reserve increases or decreases the money supply by using various tools. So in the case of the reserve requirement, the bank increases the percentage of reserve requirement if the Fed wants to decrease the money supply and to increase the money supply it reduces the reserve requirements. In the case of open market operations, the Fed sells securities and bonds in the market in order to reduce the supply of money or to decrease the supply of money it buys the securities from the market.

In the case of a discount rate, the Fed reduces the discount rate to increase the money supply because reducing the discount rate will induce the banks to give more loans. But to decrease the money supply, the Fed increases the discount rate because an increase in the discount rate reduces the ability of banks to give loans.