Tools of monetary policy, This would be a good chance to

Tools of monetary policy

Reference no: EM1374040

This would be a good chance to point out one very important information. We associate monetary rule with lower or higher interest rates, but what most people do not realize is that the Fed is actually doing is changing money supply (and not interest rates directly). When money supply changes, interest rates automatically adjust to keep the money market in equilibrium.

The 3 tools of monetary policy (the discount rate, the required reserve ratio, and open market operations) all work by changing money supply. However, it would not make any sense to any one if the Fed were to announce that it was increasing money supply by say $30 billion. What makes more sense is to announce the resulting decrease in interest rates, since people relate more to a change in interest rates and do not really understand the money supply change that brought it about.

However, as students of economics we must always keep in mind the fact that the first target of monetary policy is money supply. The Fed can change money supply by the amount desired to bring about the change in interest rates that it wants.

so monetary policy tools --> money supply change --> interest rate change.

Make sense?

Reference no: EM1374040

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