When the Fed decides to buy, it gives money to banks (or the economy), and this expands the supply of money. When
the Fed decides to sell, it takes money from banks (or the economy) and contracts the supply of money.
Mini-Review
- Which one of the following is not a tool used by the Fed?
A. Open market operations
B. Discount rate
C. Reserve requirements
D. Ta xe s
E. None of the above - Which tool does the Fed most commonly use to remedy economic instability?
A. Reserve requirements
B. Discount rate
C. Open market operations
D. Ta xe s
E. Both the reserve requirement and the discount rate - If the Fed were trying to fight a recession, it would:
A. Sell bonds
B. Raise the reserve requirement
C. Increase the discount rate
D. Buy bonds
E. Decrease taxes
Mini-Review Answers
- D.Taxes is not a tool used by the Federal Reserve. The Fed does not hold the power to tax. Taxation is fiscal
policy. - C. The Fed uses the buying and selling of securities as its most common tool for remedying instability. Reserve
requirements and discount rate changes offer a less subtle effect on the economy, increasing the likelihood of ad-
verse effects. - D. To fight a recession, the Fed buys bonds to increase the money supply. This is called “loose,” or expansionary,
monetary policy.
Monetary Policy in Action
It is the Federal Reserve’s responsibility to monitor the fluctuations of the business cycle. With its “tools,” the Fed can
influence the business cycle in one way or another. During a contractionary period, the Fed may want to implement ex-
pansionary monetary policy. The main purpose of expansionary monetary policy is to increase the money supply and
help the economy climb out of a contractionary period.
During an expansionary phase of the business cycle, the Fed may want to slow down growth to avoid inflation. To
achieve this, the Fed can decrease the money supply (contractionary monetary policy) by raising the reserve require-
ment, raising the discount rate, or selling government bonds.
Monetary Policy