Describe the three basic tools used by the Fed to change the money supply. Which of these tools is most relied on in practice? Least relied on? Why?

Question

What will be an ideal response?

Answer 1

The Fed can use open market operations, change the required reserve ratio, or change the discount rate to change the money supply. In practice, the Fed most often relies on open market operations because it is the most flexible tool. It allows for the greatest fine-tuning of the money supply. The required reserve ratio is the tool least used in practice because it is potentially so powerful. Changing required reserves could change the money supply too much in one direction or another. Its use could be much like using a sledgehammer to pound in a finishing nail.