Monetary Policy: Examining the Role of the Federal Reserve System

This report examines monetary policy, focusing on the tools and impact of the Federal Reserve. The report discusses open market operations, reserve requirements, and discount rates as tools for managing inflation and economic stability. It explains how these tools are used to implement contractionary and expansionary policies. The report references key economic concepts and the practical application of monetary policy, using examples to illustrate the effects of policy decisions. The report also highlights the importance of the Federal Reserve in maintaining a stable financial system. This assignment is a great resource for students to understand the fundamentals of monetary policy and its real-world applications.

Running head: MONETARY POLICY
Monetary Policy
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1MONETARY POLICY
Table of Contents
Article.........................................................................................................................................2
References..................................................................................................................................3

2MONETARY POLICY
Article
The Balance. (2019). How the Federal Reserve Affects Your Life Every Day. Retrieved 18
July 2019, from https://www.thebalance.com/the-federal-reserve-system-and-its-function-
3306001
The above article speaks about the role of Federal Reserve, the central bank of the
United States on maintaining the economy of the country. In the article, it is specified that
how the Federal Reserve manage the inflation rate, manages the banking system of the
country and helos in stabilizing financial system of the country as well. The Federal Reserve
uses various tools depending upon the situation to control or manage the economy of the
country and is known as monetary policy tools. There are three monetary policy tools
namely, open market operations, reserve requirement and discount rate (Walsh, 2017). All of
the three policy tools can be used either to expand or to contract the economy. Under open
market operations, the Federal Reserve sells bond for implementing contractionary monetary
policy and buys up bonds for expansionary monetary policy. Similarly, reserve requirement
of bank is increased to exert contractionary effect on the economy and is decreased to make
an expansionary effect (Wu & Xia, 2016). On the other hand, discount rate is the interest rate
charged on the amount the commercial banks borrow from the Federal Reserve. Hence,
increase in discount rate would pose a contractionary effect on the economy and vice versa.
Suppose, the economy of the United States is experiencing high inflation rate and to control it
the government need to reduce the liquidity. Decrease in liquidity of the economy reduces the
consumption and thereby demand for the goods, which will lead to lowering of inflation rate,
Thus, to do this the Federal Reserve would either sell bonds or increase the reserve
requirement of the bank or increase the discount rate as all of these policies would have
contractionary effect on the economy. In this case expansionary policy is not used because it
would increase the liquidity of the economy.

3MONETARY POLICY
References
Walsh, C. E. (2017). Monetary theory and policy. MIT press.
Wu, J. C., & Xia, F. D. (2016). Measuring the macroeconomic impact of monetary policy at
the zero lower bound. Journal of Money, Credit and Banking, 48(2-3), 253-291.