Money Growth and Inflation Assignment Paper.

List the feds main policy tools and briefly describe each of them.

There are several policy apparatuses used by the fed to control monetary policies. They include Open Market Operations, changing requirements for bank reserves, varying discount rates for borrowing, term auction facility, and interest rates on reserves as tools to control monetary policy.

1. Open market operations

The federal government can manipulate the federal fund’s rates by selling or buying government bonds. The federal funds rate is the interest the reserve charges banks which borrow from other commercial banks with large reserves. Money Growth and Inflation Assignment Paper.

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By interfering with the fund’s rates, the federal reserve can control the money supply, inflation and economic activity (Walsh, 2017). When the reserve sells government bonds, the federal funds rate increase and in turn, money supply decreases. When the reserve buys government bonds, the federal fund rates decrease and the amount of money in supply increases.

• Discount rates

The Federal Reserve gives short-term lending windows, mostly overnight to commercial banks to prevent liquidity problems (Walsh, 2017). The discount rates are not similar to market rates and are set by the Fed’s board of governors. Whenever the Federal Reserve wants to increase the supply of money, the discount rates are lowered.Money Growth and Inflation Assignment Paper. When they want to decrease the amount of money in supply, the discount rates are increased to make it difficult for commercial banks to borrow.

• Reserve requirements

The national federal system can set the minimum amount of reserves that can be held by a financial institution to a large amount to prevent increased lending and reduce the amount of money in supply. When the reserve amounts are lowered, the circulation of money in the economy increases because banks can lend more.Money Growth and Inflation Assignment Paper.

• Term auction facility

This is a program by The National Federal Reserve to increase cash liquidity in the credit market by setting up actions that allow institutions to borrow money at discounted rates. The loans go to the highest bidder. The monetary base available for the successful institutions increases and they can lend more to their customers leading to an increase in economic activity because consumers have more to spend.

• Interest rates on reserves

A Board governing the Federal Reserve determines the interest rates required for reserves. The interest rates are used to eliminate implicit tax placed on commercial deposit institutions. Money Growth and Inflation Assignment Paper.The interest rate on excess reserves is also a tool that the federal body can use to control monetary policy. Feds can increase the interest rates paid to banks on reserve without changing the reserve requirement amount. The lending ability of banks is curbed leading to a decrease in the sum of money in supply. The board can also decide to increase the money supply by lowering these interest rates to encourage lending by commercial banks.

How does inflation affect nominal interest rates? Comment on the close association between these two variables with respect to the Fisher Effect. According to the Fisher effect, how does an increase in the inflation rate affect the real interest rate and the nominal interest rate?

According to Crowder & Hoffman (1996), the nominal interest rates have a direct association with inflation, if based on the Fisher equation. The equation states that the nominal interest rates are equal to the sum of the real interest rates and the inflation rate. Therefore, the inflation rates are directly correlated to the nominal interest rates, and they both increase at the same rate. In a case where the rate at which nominal interests increase is same to the rate at which prices increase, the real interest rates consequently reduce.

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 According to the Quantity Theory of Money, what is the effect of an increase in the quantity of money?
Growth in the amount of currency in supply has an equal effect on the rate of inflation (Walsh 2017).Money Growth and Inflation Assignment Paper. Changes in the prices of products will be affected when the amount of money in supply increases. The increase in prices compensates for the decreased marginal value of money. Therefore, consumers have much money to spend, and the effect is a rise in the costs of products and services in the market. The rate at which money grows is directly proportional to the rate at which prices increase.

References

Crowder, W. J., & Hoffman, D. L. (1996). The long-run relationship between nominal interest rates and inflation: The Fisher equation revisited. Money Growth and Inflation Assignment Paper.Journal of money, credit, and banking, 28(1), 102-118. https://doi.org/10.2307/2077969

Walsh, C. (2017). Monetary theory and policy MIT press. [online] Psyso2012.khuisf.ac.ir. Available at:   http://psyso2012.khuisf.ac.ir/Prof/images/Uploaded_files/Carl%20E.%20Walsh%20Monetary%20Theory%20and%20Policy,%20Third%20Edition%20%202010[4311539]  .PDF [Accessed 27 Nov. 2018].Money Growth and Inflation Assignment Paper.