Which of The Monetary Tools Available to The Federal Reserve Is Most Often Used?

Which of The Monetary Tools Available to The Federal Reserve Is Most Often Used? 

The Federal Reserve’s three instruments of monetary policy are open market operations, the discount rate, and reserve requirements. Recently, open market operations are the most frequently used tool of monetary policy.

The Three Instruments of Monetary Policy Briefly Intro: 

I. Open market operations involve the buying and selling of government securities primarily U.S. Treasury securities on the open market to regulate the supply of money. The Federal Reserve purchases Treasury securities to increase the supply of money and sells them to reduce the supply of money. By trading securities, the Fed influences the amounts of bank reserves, and affects the federal funds rate, or the lending rate of interbank markets.

The Federal Open Market Committee (FOMC) is the entity that carries the Federal Reserve's policy. 

II. The Federal discount rate is the interest rate the Federal Reserve charges banks to borrow funds, allows Federal Reserve to control the supply of money, known as a monetary policy, to stabilize the financial markets. When the discount rate falls, it's cheaper for financial institutions to borrow money. More loans are made, the money supply increased. When the discount rate climbs, it's more expensive for financial institutions to borrow money which would be less money in the economy.

III. Reserve requirements are the portions of deposits that banks must maintain on deposit at a Federal Reserve Bank. The requirements are the amounts of funds that banks hold in reserve to ensure sudden withdrawals are able to be met. It's a tool used by the Fed to increase or decrease the money supply in the economy and influence interest rates.

So, why The Federal Reserve Used Open Market Operations Most Often?

Open market operations, the discount rate, and reserve requirements all capable of controlling the money supply effectively. However, the Fed frequently used open market operation tools as the primary monetary policy because of the flexibility. The open market operations are easily reversible. Discount loans and reserve requirement changes are more difficult to reverse quickly.  

The open market operations are also very efficient. The Fed can implement whatever it wants rapidly, with no administrative delays. But, changing the discount rate or reserve requirements require much more time to discuss.

How Expansionary Activities Conducted by The Federal Reserve Impact Credit Availability, The Money Supply, Interest Rates, and Security Prices

When the Fed uses its monetary policy tools to stimulate the economy, it increases the money supply, lowers interest rates, increases the demand, and boosts economic growth. When consumers expect prices to increase, they are more likely to buy more now. However, if the Fed puts too much liquidity into the banking system, it risks triggering inflation.

Credit Availability

Credit availability means how much money can be borrowed, given the current balance on the account. If there is a limit on the total, the credit of this account is likely to be less liquid. For example, just like your credit card account, if all available credit has been used, the credit limit has been reached, then the available credit will become zero, and you cannot purchase anything until you repay the bill to gain the credit amounts. It is kind of a risk management tool for financial institutions to limit their risk. However, the Fed also can narrow the credit rate to reduce some risky activities.

The Money Supply

The money supply is the total amount of money like cash, coins, and balances in circulation. As we already know, the Federal Reserve’s three instruments of monetary policy, the open market operations, the discount rate, and reserve requirements, can increase or reduce the money supply. 

During the expansion periods, the Fed tends to supply more money into the economy to keep it work smoothly. Reversely, reduce the money supply can limit unhealthy and overtop inflation.

Interest Rates

The Fed can lower or higher the rate it charges commercial banks while they need to borrow additional reserves. It is an administered interest rate set by the Fed, not a market rate.

During the expansion periods, if the Fed wants to give banks more reserves, it can reduce the interest rate it charges, thereby tempting banks to borrow more since it's cheaper. Alternatively, it can top up reserves by raising its rate, to achieve its goal. The expensive cost will hit the banks to reduce borrowing. 

Security Prices

Consumers tend to stock up something to avoid higher prices later, and then drives demand. Triggering businesses to produce more, and hire more workers. As income gets higher, the additional income tempting people to spend more, stimulating more demand. 

If businesses can't produce enough, they start raising prices. Securities prices are the same. Most of the time, securities prices influence how we spend our money quietly. Therefore, through open market operations, and the discount rate, the Fed tends to keep reasonable securities prices.

Reference

Federal Reserve Actions to Support the Flow of Credit to Households and Businesses. (2020, March 15). Retrieved October 06, 2020, from https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm

Monetary Policy Basics. (n.d.). Retrieved October 05, 2020, from https://www.federalreserveeducation.org/about-the-fed/structure-and-functions/monetary-policy