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LOS d: Explain the goals of the U.S. Federal Reserve (Fed) in conducting monetary policy and how the Fed uses its policy tools to control the quantity of money, and describe the assets and liabilities on the Fed's balance sheet.

Assume the economy is undergoing a recession. In its efforts to stimulate the economy by trying to influence short-term interest rates the Fed is most likely to take which two actions?

A)	Sell Treasury securities and increase bank reserve requirements.

B)	Sell Treasury securities and decrease bank reserve requirements.

C)	Buy Treasury securities and decrease bank reserve requirements.

If the economy is in a recession, the Fed is likely to attempt to decrease short-term interest rates. Thus, the Fed will buy Treasury securities and decrease bank reserve requirements.

David Wildstein, Harry Osajnuk, and Kurt Weil, are all junior economists at the Bank of Scarsdale. Over lunch they were discussing the U.S. Federal Reserve (the Fed) and the banking system in the United States. They made the following statements regarding the overall purpose of the Federal Reserve System:

Wildstein: In my opinion, the overall purpose and goal of the Federal Reserve System is to insure the deposits of individuals and firms holding funds with banking institutions.

Osajnuk: The overall goal of the Federal Reserve System is to keep the discount rate flexible so that if additional funds are needed in the economy the discount rate will be reduced and if there is too much money in the economy the discount rate will be increased.

Weil: The primary purpose of the Federal Reserve System is to regulate the amount of excess reserves held by member banks through the potential deposit expansion multiplier.

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The statements made by each of the junior economists are incorrect. The overall purpose of the Federal Reserve System is to regulate the money supply. In that way, they seek to provide for a monetary environment that is in the best interests of the economy.

Which one of the following Federal Reserve monetary policies, when pursued in line with the U.S. government’s fiscal policies, would help increase aggregate demand during a period of high unemployment?

A)	The sale of bonds by the Fed.

B)	An increase in the reserve requirements for financial institutions.

C)	A decrease in the discount rate.

A decrease in the Fed’s lending rate is a monetary tool that the Fed can use to increase the money supply, thereby increasing aggregate demand during recessionary times when there is high unemployment. An increase in the reserve requirements and the sale of bonds by the Fed would all be restrictive monetary policies that would reduce the amount of money in the economy and reduce aggregate demand.

Which of the following is least likely to appear as an asset on the U.S. Federal Reserve’s (Fed’s) balance sheet?

The assets of the U.S. Federal Reserve consist of: gold, deposits with other central banks, special drawing rights at the International Monetary Fund, U.S. Treasury bills, notes, and bonds, and loans to banks (reserves loaned at the discount rate). The great majority (over 90 percent) of the liabilities of the Federal Reserve are Federal Reserve notes, that is, U.S. currency in circulation. Bank reserve deposits are a small part of the Fed’s liabilities.

At a recent conference “The Fed – Where is it Going?”, Jason Alexdrovitch was discussing the policy tools that the U.S. central bank uses to control the money supply. During the conference he made the following statements:

Statement 1: If the Fed wanted to use all of its three major monetary policy tools to increase the money supply, the Fed would sell bonds, reduce the discount rate and increase bank reserve requirements.

Statement 2: If commercial banks are increasing their borrowings from the Federal Reserve banks, while the Fed is selling government securities, the borrowing of the commercial banks from the Fed will offset the effects of open market operations.

If the Fed wanted to use all of its three major monetary control tools to increase the money supply, the Fed would buy bonds, decrease the discount rate, and decrease the bank reserve requirements. Each of these actions would inject more money into the banking system.

When the Fed is selling government securities they are taking money out of the banking system thereby decreasing the money supply. But, if commercial banks are increasing their borrowings from the Fed, more money is being injected into the banking system. This increase in the money supply will offset the effects of the Fed’s open market operations.

Which of the following statements regarding U.S. Federal Reserve open market operations is least accurate?

A)	When the Fed buys Treasury securities, short-term interest rates will generally decrease.

B)	When the Fed sells Treasury securities, excess reserves and the monetary base decrease.

C)	If the Fed wants to stimulate the economy, it will sell Treasury securities to banks.

If the Fed intends to stimulate the economy, they will buy, not sell, Treasury securities. Buying Treasury securities increases the monetary base and injects reserves into the banking system.