Monetary Policy Impact On Macroeconomics Essay

1500 Words 6 Pages
There are 12 Federal Reserve Banks that make up the central bank in the United States of America. These 12 banks are also known as the Fed. The Fed has three tools of monetary policy they can use to control the money supply. They are open-market operations, the reserve ratio, and the discount rate. These three tools used by the Fed have an impact on gross domestic, product (GDP), inflation, interest rates, and unemployment.
Open-Market Operations
The Fed's the most important tool is the open-market operations. The open-market operations deal with buying or selling government bonds to commercial banks or to the public. When the Fed buys bonds from commercial banks, the commercial bank will have negative securities and positive reserves in
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The reserve ratio is a percentage of deposits that a bank holds as reserves. The Fed mandates a certain percentage of this ratio for commercials banks to hold in their reserves. Raising the reserve ratio can lead to a decrease in excess reserves and prevent lending abilities by commercial banks. If the Fed lowers the reserve ratio the opposite will occur, excess reserves will increase and commercial banks will be able to create money for lending.
The Discount Rate
Another tool the Fed uses is the discount rate. The discount rate is the interest rate that the Fed charges commercial banks for loans. Just as the commercial banks charge the public interest rates for borrowing money, the Fed will charge the commercial banks a discount rate for borrowing money. Borrowing funds from the Federal Reserve Bank by the commercial banks increases the reserves of the commercial banks and enhances their ability to extend credit (McConnell & Brue, 2004, p. 247). When the discount rate is increased, commercial banks will look to other commercial banks for loans and not the Federal Reserve Bank.
Affects on Macroeconomic
When the economy is facing recession or high unemployment the Fed must buy government bonds, lower the reserve ratio, or lower the discount rate. Excess reserves will increase causing the money supply to rise. Interest rates will fall causing investment spending to increase. The aggregate demand will increase causing real GDP to rise

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