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Federal Reserve's Relationship to the Money Supply

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1. Describe three ways in which the Federal Reserve can change the money supply.

2. If the Federal Reserve is going to adjust all of these tools during an economy that is growing too quickly, what changes would they make?

3. If the Federal Reserve is going to adjust all of these tools during an economic recession, what changes would they make?

4. What changes, if any, would you make to these tools at the next meeting of the Federal Reserve? Explain why and the benefits/drawbacks of this strategy.

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This solution discusses the Federal Reserve's connection to money supply in 775 words.

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1. Describe three ways in which the Federal Reserve can change the money supply.

The Fed can't control inflation or influence output and employment directly; instead, it affects them indirectly, mainly by raising or lowering short-term interest rates. The Fed affects interest rates mainly through open market operations and the discount rate, and both of these methods work through the market for bank reserves, known as the federal funds market.

So there are three tools:
open market operations
The major tool the Fed uses to affect the supply of reserves in the banking system is open market operations-that is, the Fed buys and sells government securities on the open market. These operations are conducted by the Federal Reserve Bank of New York.

discount rate
Banks also can borrow reserves from the Federal Reserve Banks at their "discount windows," and the interest rate they must pay on this borrowing is called the discount rate. The total quantity of discount window borrowing tends to be small, because the Fed discourages such borrowing except to meet occasional short-term reserve deficiencies.
The discount rate plays a role in ...

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