1.
Do some outside research on recent actions on the part of the Federal Reserve. The Fed is
essentially responsible for monetary policy. Describe the functions of the Fed and why
manipulation of the money supply has been such a prominent tactic over the past several years in
stimulating growth in the GDP.
Solution
After the events of September 11, 2001, there was a general fear that the economies of Canada
and the United States would slip into a severe recession. In response to this, the Bank of Canada
and the Federal Reserve Board very quickly began lowering interest rates. In a short period of
time, interest rates in each country were at a 40-year low. The hope was that this sudden large
drop in interest rates would stimulate output. This immediately gave rise to the question of
whether interest rates were low enough to generate some growth on the output side, and if not,
could monetary policy lower interest rates any further. That is, were the two economies each in a
liquidity trap? In Canada, the lowering of interest rates had the desired effect, as output growth
rebounded strongly in the first quarter of 2002. However, in the United States, output growth
remained sluggish and there was talk of the U.S. economy entering a period of deflation, when
prices would be falling. Of course, this led to more calls for a lowering of interest rates in the
United States and more talk of the U.S. economy experiencing a liquidity trap.
The most important tool the Fed has to conduct monetary policy is the buying and selling of U.S.
government securities, which is often referred to as open market operations.   A Federal
Open Market Committee administers the sale and purchase of U.S. government securities on the
open market to influence short-term interest rates and growth of money and credit.
Other tools that the Fed has it its disposal to influence the economy include adjustments to the
discount rate and the reserve requirement , and acting as a lender. The discount rate is the
interest rate the Federal Reserve Banks charge financial institutions for short-term loans of
reserves.
The reserve requirement is the percentage of funds a bank must set aside and hold in reserve. If
the Fed raises the reserve requirement , banks have less money to lend, which restrains the
growth of the money supply. On the other hand, if the Fed lowers the reserve requirement ,
banks have more money to lend and the money supply increases. The Fed rarely changes the
reserve requirement .

2.
Finally, as a lender, the Fed offers discount rate loans to help banks meet short-term needs, a
buffer to maintain steady reserve demand and supply.