Answer to Question #89195 in Macroeconomics for BRENDA

Question

3. In your own words, explain the difference between open market operations, the federal funds rate, the discount rate and the required reserve ratio.

Answer 1

Open market operations refers to the sale and purchase of securities in the open market by a country’s central bank. The operations play a key role in controlling money supply in an economy. Also, it is an important instrument used by the Federal Open Market Committee (FOMC), a part of the Federal Reserve in the execution of monetary policy.

     In the United States, the interest rate at which depository institutions such as banks and credit unions lend the reserve balances to other depository institutions on an overnight basis , without a collateral is called the federal funds rate.

     The discount rate is the interest rate charged by the Federal Reserve Bank to commercial banks and other depository institutions for the loans made to them by the federal reserve bank through Federal Reserve Bank's regional lending facility which is called the discount window. The three types of discount window programs are primary credit, secondary credit, and seasonal credit.  Each of them has a unique interest rate of their own.

     Every depository institution is required to keep a certain ratio funds in reserve against specified deposit liabilities. This dollar amount which is mandatory to be held is called the reserve requirement is determined by applying the reserve ratios.