Three Tools of Monetary Policy

1. Reserve Requirement

Only small % of your bank is safe.

• ER is loaned out  "Fractional Reserve Banking"
• FED sets the ER. 
• When FED increases MS, it increases the amount of money held in bank deposits. 

Recession

• Decrease RR
• Banks have less money and more ER.
• Banks create more money by loaning out excess reserves.
• Money supply increases, interest rate decreases, and AD increases.

Inflation

• Increase RR
• Banks hold more money and less ER.
• Banks create less money.
• Money supply decreases, interest rate increases, and AD decreases. 

2. Discount Rate

Interest rate that the FED charges commercial banks.

• To increase money supply, FED should lower discount rate (Expansionary)
• To decrease money supply, FED should increase discount rate (Contractionary)

3. Open Market Operations

The FED buys/sells government bonds (securities).

• To increase MS, FED should buy government securities.(Expansionary)
• To decrease MS, FED should decrease government securities.(Contractionary

Expansionary (Easy Money)

• OMO: Buy bonds
• Discount Rate: Decrease
• Reserve Requirement: Decrease

Contractionary (Tight Money)

• OMO: Sell bonds
• Discount Rate: Increase
• Reserve Requirement: Increase

Federal Fund Rate: 

• Where FDIC member banks loan each other overnight funds.

Prime Rate:

• Interest rate that banks give to their most credit-worthy customers.