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Does The Federal Reserve Use Specific Tools To Manage Money Supply?

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In this paper we will discuss how the Federal Reserve (FED), uses specific tools to manage the money supply. These tools have been put in place by the Federal Reserve to help in different ways to control the money in our country. If there is a problem such as a recession or a depression it is the job of the Federal Reserve to counter the problem by using one or more of these specific tools. The tools that will be discussed are Open Market Operations (OMOs), Fractional Reserve Banking System, and Discount and Federal Funds Target Rates. Open Market Operations are used by the Federal Reserve when buying or selling government bonds to increase or decrease the money supply. When the Federal Reserve needs to increase the money supply, they tell …show more content…

The amount of currency on hand is not as much so the money can then be loaned out to other parties. This banking system uses a reserve ratio, this is the fraction of deposits at which the bank keeps for withdrawals (Mankiw). The ratio is influenced by government regulations and banking policies. These both contribute greatly to how much currency a single bank has in its vaults on any single day. The Federal Reserve oversees these moves with the currency and inputs their view into how the money should be moved. The Federal Reserve uses a reserve requirement system at banks that says they must keep a minimum currency in the vaults (Mankiw). The reverse to this requirement is called excess reserves, where they can only hold so much money at any given time. These requirements set by the Federal Reserve is put into place to help banks feel more confident in having enough money but not so much that it is a problem. In the fractional-reserve banking system if the assets and liabilities end up equaling each other the bank is in good standings. Money is created by the banks only holding a fraction of deposits made which causes the economy to rise (Mankiw). It seems as the fractional-reserve banking system created money out of no where by only keeping fractions of currency deposited. While money is being created no wealth is being made by this system though, while money …show more content…

The federal funds rate is an interest rate that banks charge on each other when they borrow money from one another. This interest rate is a short-term rate that the banks use with each other when one banks reserves have fallen below the required currency amount (Mankiw). These loans are very short term and are typically just held overnight. The federal funds rate is the price of the loan sent to one bank from another. The federal funds rate and the discount rate differ in the way that the federal funds rate is borrowed from bank to bank while the discount rate is when a bank borrows from the Federal Reserve (Mankiw). If a bank is short on currency at a specific time, then they will do borrow in the cheapest way possible for them. The Federal Reserve sets a target goal for the federal funds rate and a meeting is set every month and a half to decide whether this rate should be higher or lower. Both rates are controlled by the Federal Reserve in the big picture but there are small discrepancies that can be made below the Federal Reserve. The money supply is not affected much by these rates but the creation of money in the economy is increased while the wealth is not impacted

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