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    Instruments of Monetary Policy

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    3) Explain the three major instruments of monetary policy and the effect on short run vs. long run output in an economy.

    How does the Federal Reserve Bank control the quantity of credit?

    Explain how the Fed through its policies and tools, affects overall prices, output, employment, and interest rates?

    Prepare a Federal Reserve Bank balance sheet using the following data:

    1) $100 Billion of Federal reserve Notes
    2) $42 Billion of deposits including Member bank Federal Reserve Notes
    3) $12 billion of Gold certificates
    4) $110 Billion of U.S. Government securities
    5) $5 billion of discount, loans, and acceptances
    6) $10 Billion of miscellaneous debts
    7) $28 billion of other assets
    8) $?? Capital accounts

    When the Federal Reserve Banks buy $10 million of government bonds from the public, explain the initial impact on the balance sheets of the Federal Reserve Banks and the Commercial banks.

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    Solutions:

    3) (i)

    The three major instruments of monetary policies are open market operations, reserve requirements, & discount window.

    Open market operations:
    Open market operations are the most important and active tool of monetary policy that the FED uses. These operations consist of the FED buying and selling previously issued U.S. Government securities, or IOUs of the Federal Government. When the FED adopts an expansionary monetary policy, it will buys government securities from a firm that deals in them. So, the FED will provide extra credits to the banking systems in the form of payment in the dealers account & the money supply in the economy will be increased. This will boost the economy. When the FED adopts contractionary monetary policy, it sells the government securities & drains the credit. This will control the overheating economy.
    Reserve requirements:
    Reserve requirements are the percentages of certain types of deposits that banks must keep on hand in their own vaults or on deposit at a Federal Reserve Bank. The FED will decide about the reserve requirements. During the slow down of economic activities, the FED will lower the reserve ...

    Solution Summary

    This post shows the instruments of monetary policy.

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