Examples of Monetary Policy Instruments Used by the Federal Reserve

📚 Quick Study Guide

• 💰 Reserve Requirements: These are the fraction of a bank’s deposits that they must keep in their account at the Fed or as vault cash. An increase in reserve requirements reduces the money supply.
• 🏦 Discount Rate: The interest rate at which commercial banks can borrow money directly from the Fed. A lower discount rate encourages borrowing, increasing the money supply.
• 📈 Federal Funds Rate: The target rate that the Federal Reserve wants banks to charge one another for the overnight lending of reserves.
• 📊 Open Market Operations: The buying and selling of U.S. government bonds by the Fed to influence the quantity of bank reserves and the level of the federal funds rate. Buying bonds increases the money supply; selling bonds decreases it.
• 📜 Inflation Targets: Explicit announcements of the inflation rate the Fed is trying to achieve. This can influence expectations and thus actual inflation.
• 🗣️ Quantitative Easing (QE): When the Fed purchases longer-term government bonds or other securities. This increases bank reserves and reduces long-term interest rates.
• 💸 Interest on Reserve Balances: The Fed pays interest to banks on the reserves they hold at the Fed. Raising this rate can decrease the money supply.

🧪 Practice Quiz

1. Which of the following is NOT a monetary policy instrument used by the Federal Reserve?
   1. Open Market Operations
   2. Government Spending
   3. Discount Rate
   4. Reserve Requirements
2. What happens to the money supply when the Federal Reserve buys government bonds?
   1. The money supply increases.
   2. The money supply decreases.
   3. The money supply remains unchanged.
   4. The effect on the money supply is indeterminate.
3. The interest rate at which commercial banks can borrow money directly from the Fed is known as the:
   1. Federal Funds Rate
   2. Prime Rate
   3. Discount Rate
   4. LIBOR
4. What is the primary goal of quantitative easing (QE)?
   1. To decrease short-term interest rates
   2. To increase long-term interest rates
   3. To increase bank reserves and reduce long-term interest rates
   4. To decrease bank reserves and increase long-term interest rates
5. If the Federal Reserve increases the reserve requirement, what is the likely effect on the money supply?
   1. The money supply will increase.
   2. The money supply will decrease.
   3. The money supply will remain the same.
   4. The effect is unpredictable.
6. What does the Federal Reserve target when using the federal funds rate as a policy instrument?
   1. The inflation rate
   2. The unemployment rate
   3. The interest rate banks charge each other for overnight loans
   4. The exchange rate
7. Which of the following tools allows the Federal Reserve to directly influence the amount of money banks have available for lending?
   1. Forward guidance
   2. Inflation expectations
   3. Interest on reserve balances
   4. Fiscal policy