Answer to Question #98413 in Macroeconomics for Tiffany

Question

2. The U.S. Federal Reserve is the central bank of the United States. It has many roles in the economy, but one of the key roles is conducting monetary policy.
b. Suppose the Fed wants to close an inflationary gap. How could it use each of the three tools of monetary policy to close the gap?

Answer 1

The Federal Reserve's three instruments of monetary policy are open market operations, the discount rate and reserve requirements.When the economy is in an inflationary gap, the Fed will adopt a contractionary monetary policy to decrease the money supply in the market by follow steps:

1. selling securities, which the banks are forced to buy. That reduces their capital, giving them less to lend. As a result, they can charge higher interest rates.

2. raising the reserve rate (increasing of reserves keeps money out of circulation),

3. increasing the discount rate, which also reduces amount of the money in circulation.