The Fed rarely changes the reserve requirement, but it is one of three tools it can use to implement monetary policy. All three monetary policy tools affect the level of reserves in the banking system and the supply of loanable funds. We’ll look at the process of money creation later in this chapter. First, let’s get familiar with the Fed’s main tools of monetary policy:
• Open market operations
• Changes in the discount rate
• Changes in reserve requirements
We’ll take these tools one at a time, but first a word of caution: although writers use the phrase control the money supply, the Fed doesn’t really control the money supply, let alone the economy. Instead, using these tools, the Fed influences the demand for and the supply ...