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tools of the Federal Reserve

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1. What are the three tools the Federal Reserve uses to change the money supply and interest rates in the economy? Which of these tools is most important and why?

2. In each of the following cases, explain whether the statements are true or false, and why:
a. If the real money demand is greater than the real money supply, interest rates must rise to reach the equilibrium in the money market as people sell bonds to
obtain more money (cash).
b. The federal governmentâ??s control of money supply, which influences the interest
rates, is the primary tool that policy makers use to impact the macro economy.
c. A decrease in the reserve requirement decreases the money supply because banks
have fewer reserves.
d. The real money demand curve shows how households and businesses change their
spending in response to changes in interest rate.

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Solution Summary

The three tools the Federal Reserve uses to change monetary policy are discussed.

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1. The three tools the Federal Reserve uses to change monetary policy are:
a. Open market operations.
b. Discount window operations.
c. Changes in required reserve ratio.
Out of these the most important one, and the one most frequently used is open market operations that involves buying and selling treasury bills in the money market. When the Fed wants to lower interest rates and increase money supply it buys treasury bills in the open market and thus ...

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