List and explain the three tools used by the Fed to manipulate the supply of money. In each case show how the money supply can increase/decrease.
This site should help you.
http://www.investopedia.com/articles/economics/08/monetary-policy-recession.asp
The Federal Reserve (Fed) uses a variety of tools to manipulate the supply of money in the economy. The three main tools are Open Market Operations, Reserve Requirements, and Discount Rate.
1. Open Market Operations (OMO):
Open Market Operations refer to the buying and selling of government securities, such as Treasury bonds, by the Fed in the open market. By purchasing government securities, the Fed increases the money supply in the economy, while selling them decreases the money supply.
- Increasing Money Supply: When the Fed buys government securities, it pays for them with new money that it creates. This injects more money into the banking system, which leads to an increase in the money supply. Banks then have more funds available to lend to businesses and individuals, thereby stimulating economic activity.
- Decreasing Money Supply: Conversely, when the Fed sells government securities in the open market, it reduces the amount of money in the banking system. This decreases the money that banks can lend, leading to a contraction in the money supply.
2. Reserve Requirements:
Reserve Requirements are the percentage of deposits that banks are required to hold as reserves. The Fed sets these requirements, and changes to these requirements can affect the amount of money banks can lend.
- Increasing Money Supply: If the Fed decreases the reserve requirements, banks are required to hold less money in reserve and can lend out a larger portion of their deposits. This increases the amount of money available for lending in the economy and expands the money supply.
- Decreasing Money Supply: Conversely, if the Fed increases reserve requirements, banks are required to hold more money in reserve, which reduces the funds available for lending. This results in a contraction of the money supply.
3. Discount Rate:
The Discount Rate is the interest rate at which banks can borrow funds directly from the Federal Reserve. The Fed can adjust this rate to influence the borrowing behavior of banks.
- Increasing Money Supply: If the Fed lowers the discount rate, it encourages banks to borrow more money from the Fed. This increases the amount of money available for lending in the banking system, leading to an expansion in the money supply.
- Decreasing Money Supply: On the other hand, if the Fed raises the discount rate, it makes borrowing from the Fed more expensive for banks. This discourages borrowing and reduces the money available for lending, resulting in a contraction in the money supply.
By utilizing these three tools, the Fed can effectively manipulate the supply of money in the economy to influence economic activity and maintain stable prices.