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The Monetary Policy Tools

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Identify the four major tools of monetary policy. Then describe how changes in the Fed's major policy tools leads to: 1. Expansionary monetary policies
2. Restrictive or contradictory monetary policies.

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Monetary policy tools:
1. Open market operation.
To increase money supply (expansionary monetary policy), the Fed will perform an open market purchase. In this case, the Fed will by US government Treasury securities from the open market. The Fed will pay the purchase with currency, therefore, the monetary base will increase by the amount of purchase.
ie. Money supply = monetary base (x) money multiplier.

You can also show the effect on this policy by using the graph of the money market based on the liquidity preference model. The graph shows the relationship between interest rate on vertical axis and quantity of money on a horizontal axis. The demand for money is negatively related to the interest rate, whereas, the money supply is fixed determined by the Fed (a vertical line at the amount of money supply). Through an open market purchase, the money supply will increase and the money supply curve will shift to the right by the amount of purchase.

An increase in money supply is expansionary, ie outputs are expected to increase mostly through the investment channel. That is a reduction in the interest rate will lead to the increase in investment and ...

Solution Summary

This solution looks at the four major tools of monetary policy implemented by the Fed and gives an in-depth explanation of each one as well as situation examples. The tools are also discussed in relation to expansionary and restrictive/contradictory policies.

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The key objectives and what are the conventional monetary policy tools

3A) What are the key objectives and what are the conventional monetary policy tools does the Fed use to achieve those objectives?

Then you read the speech given by the Fed's Chairman Bernanke on Oct 11, 2011 at the Federal reserve Bank of Boston at this url link http://www.federalreserve.gov/newsevents/speech/bernanke20111018a.htm of the Fed's website to answer the following question 3B.

3B) Read the speech of the Fed Chairman Ben Bernanke he delivered on Oct 18, 2011 at the Federal reserve bank of Boston, which is available at this url link http://www.federalreserve.gov/newsevents/speech/bernanke20111018a.htm

After reading the contents of his speech topic, "The Effects of the Great Recession on the Central Banks' Doctrine and Practice", critically and briefly analyze the direction of changes in monetary policy practice of the Federal Reserve from its conventional monetary policy framework in the wake of the great recession the US economy currently faces.

Alternatively (for 3.b),
3.b. Read the following two news analysis on the effect of monetary policy actions on November 30, 2011 by China on the global market, including US stock market. Based on your knowledge on monetary actions and its impact on the economy, briefly analyze the connection between the reduction of reserve requirement by China's central bank and its economy plus the economy of the rest of the world, including the US economy.

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