The Fed's the most important tool is the open-market operations. The open-market operations deal with buying or selling government bonds to commercial banks or to the public. When the Fed buys bonds from commercial banks, the commercial bank will have negative securities and positive reserves in assets. The positive reserves will increase the lending ability of the commercial banks. The commercial bank will have positive reserves in assets and positive checkable deposits in liabilities and net worth, when the Fed buys bonds from the public. Buying bonds from the public is similar to buying bonds from commercial banks. They both increase the lending ability of the commercial banks.
The opposite will occur when the Fed sells government bonds to commercials banks. The commercial bank will have a positive for securities and a negative for reserves in assets. The negative reserve in assets will decrease the lending ability of the commercial banks. The Fed selling to the public will cause the same result as selling to commercial banks. The commercial banks will have negative reserves in assets and negative checkable deposits in liabilities and net worth. Commercial banks and the public are willing to buy or sell government bonds to the Fed depending on the price of bonds and their interest ...
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... are made throughout simulation to increase money and decrease money in the system to control the monetary policies. The simulation shows how controlling the money supply has an impact on the economy. Creating the right balance between GDP and inflation is critical for the economy.
The Fed uses easy money policy to increase the money supply when real GDP is low and unemployment is high; however, the Fed must keep a watch on inflation because GDP and inflation tends to work in the same direction. Once inflation gets to a certain point, the Fed will use a tight money policy to decrease the money into the system. Controlling the money supply is critical to the economy. Balancing inflation and real GDP plays a major role in the economy.
McConnell & Brue (2004). Economics: Principles, problems and policies. New York: The McGraw-Hill Companies.
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