1. Discuss the three tools of monetary policy and how each would be used to fight inflation.

The article identifies open market operations as one of the three tools of monetary policy. The other two are the discount rate and the reserve requirement, and open market operations. Each is used to influence the interest rate. During periods of inflation the Fed would want to raise the interest rate in an attempt to slow down economic activity. The discount rate is the rate the Fed charges member banks to borrow reserves from the fed. To fight inflation the Fed would increase the discount rate. The reserve requirement is the percent of deposits that commercial banks must hold as reserves with the Fed. In order to fight inflation the Fed would increase the reserve requirement. Finally, the Fed can use open market operations where they buy and sell securities in the open market to influence the interest rates. To combat inflation the Fed would sell securities which will remove reserves from the banking system and increase interest rates.

2. Explain the notion of an easy money policy.

Easy money policy refers to a situation where the Fed wants to increase borrowing and spending in the economy. Effectively they need to increase the money supply. The Fed could use any of the three tools of monetary policy to achieve this goal. The most often used tool is open market operations used in precisely the same way as described above. The opposite of easy money policy is referred to as tight money policy and is the exact opposite of the description given in the answer to question 1 above.

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