nd tool available to the FED is the Discount rate. The discount rate is the rate the FED charges depository institutions when they borrow reserves. By this, the FED can affect the quantity of loans or the price of loans (discount rate). In either case, when a bank takes out a discount loan from the FED, that bank's reserves will increase, thus increasing reserves in the Federal Reserve System. This tool also allows the FED to prevent financial panic as they are the lender of last resort.The third tool is Reserve Requirements. This a requirement regarding the amount, or percentage, of funds banks, and other depository institutions, must hold in reserve against their deposits. "Currently, the reserve requirement equals 3 percent of the first $49.3 million of a bank's 'transaction deposits' (demand deposits and other checkable accounts) plus 1 percent of amounts beyond that." [Bennett & Hilton 1997] Reserve requirements are important in that they help ensure a stable and predictable demand for reserves. This increases the FED's control over short-term interest rates, namely the fed funds rate. As we will see, this requirement also helps in the conduct of open market operations.Of the three tools described above, the tool used most often is open market operations. This is due to certain advantages open market operations over the other tools of monetary policy. First, open market operations is conducted at the initiative of the FED, which allows them to have complete control over the volume of activity. The second advantage is that open market operations can be specific and flexible, therefore can be used to any extent necessary. Another advantage is that open market operations are reversible in the event a mistake is made. Open market operations can also be implemented immediately, without delay. Since open market operations is so important in the Federal Reserve Bank's conduct of monetary policy, we will focus on open market...
