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LOS b: Describe how the Fed conducts monetary policy and explain the Fed’s decision-making strategy, including an instrument rule, a targeting rule, open-market operations, and the market for reserves.

A)	the rate of inflation and the output gap.

B)	the rate of growth of the monetary base using the quantity theory of money.

C)	bringing expected inflation into line with a target rate.

The Taylor rule is an instrument rule that is based on the rate of inflation and the output gap. The McCallum rule focuses on the rate of growth of the monetary base using the quantity theory of money. Inflation targeting is a targeting rule that uses open market operations and manages the overnight rate in order to bring expected inflation in line with the target rate.

When the Federal Reserve sells government securities on the open market, bank reserves are:

A)	decreased, which reduces the amount of money banks are able to lend, causing an increase in the federal funds rate.

B)	increased, which increases the amount of money banks are able to lend, causing a decrease in the federal funds rate.

C)	decreased, which reduces the amount of money banks are able to lend, causing a decrease in the federal funds rate.

When the Federal Reserve wants to increase the federal funds rate through open market operations, it sells government securities. Open-market sales reduce bank reserves and cause the federal funds rate to increase.

Which of the following is an example of a central bank utilizing an inflation targeting rule to guide monetary policy?

A)	Setting the federal funds rate at a level that will cause the forecast inflation rate to equal the central bank’s goal inflation rate.

B)	Using the Taylor rule to set the target federal funds rate.

C)	Using open market operations to set a target federal funds rate based on the current performance of the economy.

Inflation targeting rules require the central bank to manage its target overnight interest rate so that forecast inflation rate equals the target inflation rate. Instrument rules, such as the Taylor rate, base the target federal funds rate on the current performance of the economy.