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The Federal Reserve (Fed) uses three main tools to implement monetary policy in the US: Open market operations: Buying or selling federal government bonds Discount rate: Changing the discount rate, which affects how much banks loan Reserve requirements: Changing reserve requirements
Other tools the Fed uses include: Term Auction Facility: Provides financial institutions with access to Fed dollars to alleviate short-term cash needs Term Securities Lending Facility: Allows institutions to swap out mortgage-backed CDOs in exchange for U.S. Treasuries
The Fed controls the monetary policy tools to ensure economic growth while controlling the supply of money and the aggregate demand in the economy. The Fed generally pursues a contractionary monetary policy when it considers inflation a threat. A contractionary policy could include selling bonds, which shifts the supply curve for bonds to the right, lowering the price of bonds, and increasing the interest rate.
Related Test: Money, Banking, and Financial Markets Practice Test: The Money Supply Process
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