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What Are the Different Types of Monetary Policy?

The United States Federal Reserve employs five types of monetary policy.
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  • Written By: Kristie Lorette
  • Edited By: O. Wallace
  • Last Modified Date: 16 September 2014
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In the US, the Federal Reserve uses five different types of monetary policy. The five types of monetary policy are bank reserve requirements, the federal funds market, open market operations, the discount rate, foreign currency operations. The Federal Reserve uses these types of monetary policy to control the economic conditions in the country. Other countries may use a mix of policies that are similar, depending on their type of economy.

The first of the types of monetary policy is the set of bank reserve requirements that the Federal Reserve requires banks to hold. The bank reserve is a minimum amount of money that the bank is required to keep in the bank’s account. This is money that cannot be given out to customers as loans or used for other purposes. When the Federal Reserve wants to stimulate the economy, it lowers the bank reserve requirement. When the Federal Reserve wants to institute a more restrictive monetary policy, it increases the bank reserve requirement.

The federal funds market is the short term lending market between banks. In fact, it is only an overnight loan. When the Federal Reserve wants to discourage this lending and borrowing, it will increase the interest rate in the federal funds market. When it wants to increase this type of lending, the Federal Reserve will decrease the lending interest rate.

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One of the other types of monetary policy tools the Federal Reserve uses is open market operations. Open market operations is the market in which the Federal Government sells or buys government securities, such as US Treasuries. The Federal Reserve will buy government securities when it wants to decrease the interest rate in the open market. It sells securities when it wants to increase the interest rate.

When banks in the Federal Reserve borrow money directly from the reserve, it lends this money at the discount rate. When the Federal Reserve wants to discourage banks from borrowing money from it, it increases the interest rate. When it wants to encourage the banks to borrow money from the Federal Reserve, the Fed decreases the discount rate.

The Federal Reserve also uses foreign currency operations as one of its types of monetary policy. The actions in the Federal Reserve take in the foreign currency market influence the value of the US dollar. If the Federal reserve wants to increase the value of the dollar, it will sell foreign currency to help bring up the value of the dollar and make foreign currency less expensive for Americans in foreign currency exchanges.

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SteamLouis
Post 3

Are foreign currency operations a good way to stabilize the economy? I just read in the news today that the Central Bank of a country is buying their national currency with foreign currency from their reserve to reduce inflation. Apparently, it's not working too well. I'm not an economic expert but this seems like a bad idea to me. I suppose selling foreign currency will reduce the value of that currency, but I don't think it's going to create any long term effect. It will a minor, temporary change.

Do we have any economy experts here who can shed more light on this? Do you think that foreign currency operations are effective?

ddljohn
Post 2

ZipLine-- Contractionary monetary policy is the same as restrictive monetary policy. These terms are used interchangeably. Sometimes, expansionary is also called "easy monetary policy."

Contractionary monetary policy aims to slow down the economy by reducing money supply to reduce spending and inflation. This is done when demand is greater than supply and when inflation is too high. The Federal Reserve's main tool is bank interest rates. Interest rates are increased to reduce lending.

Expansionary monetary policy is the opposite and aims to speed up the economy by increasing money supply and inflation. This is done by reducing interest rates.

ZipLine
Post 1

What is the difference between contractionary monetary policy and expansionary monetary policy?

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