For money related strategy, the Fed generally
utilizes different types of financial arrangement instruments particularly the
discount rate, reserve requirements like CRR and SLR, open market operations,
repo and reverse repo rates and margin necessities. Such arrangements manage
the cash in the economy and with the money multiplier regulate the measure of
cash accessible to the general population alongside forex reserves to regulate
the imports and stability of the dollar (Woodford, 2011).
Some of the policies are encompassed as below:
Interest on the Reserves: It was one of the
most recent device utilized by the Fed by the Congress particularly after the
Financial Crisis of 2007-2009. It is fundamentally the premium paid by the
Reserve Banks on the sum saved by the banks with the Reserve. It colossally impacts
loaning operations of the bank. For instance, if the Fed needs the bank to loan
more cash out to the general population to expand the cash supply, it may
diminish the financing cost it pays to hold the stores and the other way
Discount rate: Interest charged by Reserve
Banks on money loaned by business banks. Loaning by Fed fills in as a
reinforcement for liquidity for banks. Lower discount rates energizes spending
and higher rebate rates empowers savings.
Reserve Requirements: Amount hold by banks
either as vault money or with stores with the Reserve Bank. A decline prompts
more money accessible with the bank to loan to people in general and an
expansion implies less cash accessible to the bank to loan consequently
Open market operations: this involves lending/borrowing
by the Government and is the most used monetary policy. The Government borrows
from the public via sale of treasury bills to fund its deficit budget and
control the inflation as well as forex reserves.
Why the Fed does not use discount rate as a
The system for the discount rate is as per
the following: the banks obtain cash from the Fed to fulfill quick necessities.
They need to give an collateral like U.S Treasury Bills, notes, Commercial
Deposits, contract upheld securities and so on to obtain cash from the Fed. The
Fed by and Reserve Bank charges the Fed financing cost which is 0.5% higher
than the overnight acquiring rate as it lean towards bank to get cash from each
other as opposed to depending on the Fed to give cash. It is a negative sign
that the bank can’t get credits from different banks and needs to acquire from
Fed. This will make different banks somewhat objecting while loaning cash to
this particular bank later on. The Fed utilizes the rebate window if all else
fails to impact economy in two routes: first by raising the markdown rate to
lessen cash supply (contractionary financial strategy) and second by
diminishing the markdown rate to expand cash in the economy (expansionary money
related approach) to invigorate development (Mayer, 1968).
tool is most used by Fed for effective monetary policy?
Fed generally uses the open market
operations as an effective monetary policy tools. Using the market, the Fed
usually sells or buys Government securities to regulate the money supply in the
market. It is one of the best tools to control inflation and also balance of
payments. Whenever the money supply in the market rises, the Fed issues T-bills
to raise money from the public hence decreasing the money available with the
public. The government can then use the money to fund capital receipts to
promote growth in the economy. Also, it can use the money to fund the deficit
expenditure (Odell, 2014). When the money supply in the market decreases, the
Fed can buy back such securities from the market, infusing more money into the
economy and the consumption of the public will increase reading to more
aggregate demand and hence growth. During balance of payment crisis, Fed can
sell/buy currency of other countries, thus regulating the price of the dollar
and keeping it stable.