For the banks borrow short term money

For money related strategy, the Fed generallyutilizes different types of financial arrangement instruments particularly thediscount rate, reserve requirements like CRR and SLR, open market operations,repo and reverse repo rates and margin necessities.

Such arrangements managethe cash in the economy and with the money multiplier regulate the measure ofcash accessible to the general population alongside forex reserves to regulatethe imports and stability of the dollar (Woodford, 2011).Some of the policies are encompassed as below:Interest on the Reserves: It was one of themost recent device utilized by the Fed by the Congress particularly after theFinancial Crisis of 2007-2009. It is fundamentally the premium paid by theReserve Banks on the sum saved by the banks with the Reserve. It colossally impactsloaning operations of the bank. For instance, if the Fed needs the bank to loanmore cash out to the general population to expand the cash supply, it maydiminish the financing cost it pays to hold the stores and the other wayaround. Discount rate: Interest charged by ReserveBanks on money loaned by business banks.

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Loaning by Fed fills in as areinforcement for liquidity for banks. Lower discount rates energizes spendingand higher rebate rates empowers savings. Reserve Requirements: Amount hold by bankseither as vault money or with stores with the Reserve Bank. A decline promptsmore money accessible with the bank to loan to people in general and anexpansion implies less cash accessible to the bank to loan consequentlycontrolling inflation.Open market operations: this involves lending/borrowingby the Government and is the most used monetary policy.

The Government borrowsfrom the public via sale of treasury bills to fund its deficit budget andcontrol the inflation as well as forex reserves. Why the Fed does not use discount rate as amonetary policy?The procedure for the discount rate is asfollows: the banks borrow short term money from the Fed to satisfy immediaterequirements. They have to provide a collateral generally in the form of U.STreasury Bills, notes, Commercial Deposits, mortgage- backed securities etc. toborrow money from the Fed.

The Fed generally charges the Fed interest ratewhich is 0.5% higher than the overnight borrowing rate as it prefers bank toborrow from each other rather than relying on the Fed to provide money. It is anegative sign that the bank cannot get loans from other banks and has to borrowfrom Fed. This will make other banks slightly disapproving while lending moneyin the future. It uses the discount window as the last resort to influenceeconomy in two ways: first by raising the discount rate to reduce money supply (contractionarymonetary policy) and second by decreasing the discount rate to increase moneyin the economy (expansionary monetary policy) to stimulate growth (Mayer, 1968).

Whichtool is most used by Fed for effective monetary policy?Fed generally uses the open marketoperations as an effective monetary policy tools. Using the market, the Fedusually sells or buys Government securities to regulate the money supply in themarket. It is one of the best tools to control inflation and also balance ofpayments. Whenever the money supply in the market rises, the Fed issues T-billsto raise money from the public hence decreasing the money available with thepublic. The government can then use the money to fund capital receipts topromote growth in the economy.

Also, it can use the money to fund the deficitexpenditure (Odell, 2014). When the money supply in the market decreases, theFed can buy back such securities from the market, infusing more money into theeconomy and the consumption of the public will increase reading to moreaggregate demand and hence growth. During balance of payment crisis, Fed cansell/buy currency of other countries, thus regulating the price of the dollarand keeping it stable.


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