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There are 12 Federal Reserve Banks that make up the central bank in the United States of America. These 12 banks are also known as the Fed. The Fed has three tools of monetary policy they can use to control the money supply. They are open-market operations, the reserve ratio, and the discount rate. These three tools used by the Fed have an impact on gross domestic, product (GDP), inflation, interest rates, and unemployment.
Open-Market Operations
The Fed's the most important tool is the open-market operations. The open-market operations deal with buying or selling government bonds to commercial banks or to the public. When the Fed buys bonds from commercial banks, the commercial bank will have negative securities and positive reserves in assets. The positive reserves will increase the lending ability of the commercial banks. The commercial bank will have positive reserves in assets and positive checkable deposits in liabilities and net worth, when the Fed buys bonds from the public. Buying bonds from the public is similar to buying bonds from commercial banks. They both increase the lending ability of the commercial banks.
The opposite will occur when the Fed sells government bonds to commercials banks. The commercial bank will have a positive for securities and a negative for reserves in assets. The negative reserve in assets will decrease the lending ability of the commercial banks. The Fed selling to the public will cause the same result as selling to commercial banks. The commercial banks will have negative reserves in assets and negative checkable deposits in liabilities and net worth. Commercial banks and the public are willing to buy or sell government bonds to the Fed depending on the price ...