Federal Reserve
Open market operations
This is defined as the basic tool used by the Federal Reserve to regulate bank reserves supply. It therefore encompasses the sales and purchase of financial instruments which in many cases involves issued securities by the Federal Agencies, the US Treasury, and enterprises which are government sponsored. Under the supervision of FOMC, open market operations are undertaken by the trading domestic desk of Federal Reserve Bank. The Federal Reserve Bank uses the open market operations to regulate the amount of money in circulation in the economy. It therefore involves taking money out and putting money into the banking system.
In order to take money out of the banking system, the Federal Reserve sells government securities to the banks. Government securities are simply a piece of paper with the details that the government owes a certain sum of money to the bank. Hence, the Federal Reserve drains money from the banking system by issuing such securities. With less money in reserves, banks are discouraged from lending to the public which ensures that the amount of money in the hands of the public reduces. In order to inject more money into the economy, the government buys the securities sold to banking system which increases the strategic reserves of banking institutions. With more money in the strategic reserves, banks are encouraged to lend to the public which increases the money in the hands of the public. The term open market is used to refer to this tool because different dealers compete for prices in an open market.
Discount and Fed Funds Rate
Feds Funds rate is defined as the rate of charges for overnight loans which banks advances to each other. The reserves are held by Fed and therefore banks can decide to lend to each other drawing funds from Fed. The Feds Funds Rate is not determined by Fed but it is actually determined by the market. On the other hand, discount rate is the rate of interest set by Fed for any amount of money borrowed by member banks in an overnight. The objective of using a discount rate is to encourage member banks to use other alternative means of funding and only use the discount rate option as the last resort. By using the two rates above, Fed helps to stir up economic activities. For example, when the economic activities are slow or on a downward trend, Fed lowers the two rates above to encourage the public to borrow making it easier for businesses and consumers to build and buy. Hence, more money is injected into the hands of the public. On the other hand, when economic activities are on a higher note, Fed raises the rates above to discourage the public from borrowing and thus money is drawn from the hands of the public. This helps in curbing inflation, depression and recession.
Required Reserve Ratio and Depository Expansion
This is another instrument used to regulate money supply in the economy. It is defined as the balance that depository institutions are required to hold which they also trade in the financial market through lending to the public and borrowing from the Fed Reserves. The responsibility of setting the required reserve ratio is bestowed upon the Board of Governors. The purpose of having the required reserve ratio is to ensure that the banking system has sufficient funds to advance to the public as loans in order to stimulate the economy as well as remaining profitable in the business. In the same regard, Depository Expansion is used for the purpose of ensuring that banks can handle large amounts of money from the public as deposits. This ensures that excessive money in the hands of the public ends up in the banks as deposits to curb inflation.
In the current economic situation, Fed can successfully use the above tools to stimulate economic activities. It is worth noting that the country is recuperating from the effects of recession characterized by slow economic activities. In this respect, expansionary monetary policies which entail buying of securities from the banking system through open market operations in order to inject more money into the economy, lowering discount and Fed Funds Rate to encourage the public to borrow money from banks in order to buy industrial goods and lowering the reserve ratio to ensure that banks use more money in their reserves to lend to the public are some of the measures which can be undertaken to address the current economic situation in the country. It is imperative to note that money is the mostly used medium of exchange in the market and hence injecting more money into the hands of the public today would encourage the public to buy more capital and consumer goods. Hence production would also be stimulated bringing back the economy on a stable path.
In conclusion, the three monetary regulatory tools above are used by Fed to ensure that stable prices of goods and services are achieved in the economy. In addition, they are also used to achieve maximum production of goods and services in order to create more employment. It is important for the policy makers today to understand the proper working of the above tools in order to utilize them to stimulate economic activities to end the effects of the recession.