Answer to Question #119017 in Macroeconomics for Aynul

Question

Explain in details three (3) tools that a government can utilize while deploying expansionary/contractionary Monetary Policy.

Answer 1

1) Open Market Operations

This is seen clear when central banks buy or sell securities. They are either bought from or sold to the country's private banks. When the central bank buys securities, it adds cash to the banks' reserves which then gives them more money to lend to their respective customers. When the central bank sells securities, reduces its cash holdings of banks. The central bank will buy securities when it wants expansionary monetary policies. The central banks will sells securities when it executes contractionary monetary policies.

2. Reserve Requirement

This refers to the money banks must keep on hand for a short time. Banks can either keep the reserve in their vaults or at the central bank. In addition a low reserve requirement allows banks to lend more of their deposits. Since it creates credit, while a high reserve requirement makes the banks to lend less money. This reserve requirement is refered as contractionary monetary policy.

3) Discount Rate

This is the rate at which the central banks charge its members or customers to borrow at a discount. Since the rate is higher than the fed funds rate, banks will only use this if they can't borrow funds from other banks including the central bank.