The Federal Reserve believes that a certain rate of interest on Federal Funds is associated with price stability (which is 2% rate of inflation). However, the Federal Funds rate tends to fluctuate with the changes in the demand for federal funds by the banking system. Hence, to maintain the Federal Funds rate at the desired rate or to raise it or lower it to a new rate the Federal Reserve System undertake open market operations, or few other measures.

1. What are the four tools of monetary policy?

1. Open Market Operations to target Fed Funds Rate

2. Required Reserve Ratio

3. Discount Rate

4. Interest Rate offered to excess reserves

2. Draw a diagram of the Federal Funds market and show changes of the Fed Funds Rate as a result of the following. (draw separate diagrams for each of these cases).

1. Fed undertakes an Open Market Sale
2. Fed undertakes an Open Market Purchase
3. Fed lowers the discount rate
4. Fed raises the interest rate on excess reserves
5. Fed raises the required reserve ratio
6. The demand for federal funds increases
7. The demand for federal funds shifts decreases