The Tools of The Fed By: Ben Quick

The Four Tools of Monetary Policy 1. The Reserve Requirement 2. Open Market Operations 3. The Discount Rate 4. Interest on Reserves

The Reserve Requirement The Fed can affect money supply by changing the reserve requirement The Fed requires that member banks keep a certain percentage of their deposits in reserve Every time a bank customer makes a deposit, the bank must set aside a portion of the deposit as reserves

Open Market Operations The Fed, through the Federal Open Market Committee (FOMC), can affect the money supply by buying and selling government securities (open market operations) If the Fed sells securities, then it removes money from circulation If the Fed buys securities, then it puts more money into circulation

The Discount Rate The Fed can affect the money supply by changing the discount rate – the interest rate the fed charges on loans to financial institutions Raising the rate will decrease the money supply Lowering the rate will increase the money supply

Interest on reserves The Fed pays interest to banks on the amount they keep in reserve This is to offset the opportunity cost of not being able to loan out the money held in reserve By raising the interest on reserve, they make it more beneficial for banks to keep money on reserve in excess of the reserve reuirement

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