Monetary Policy & the Fed

Expect a question that hands you a goal — “fight inflation” or “combat a recession” — and asks which Fed action fits. The hinge is direction: to tighten/slow the economy, the Fed sells securities, raises the discount rate, or raises reserve requirements; to ease/stimulate, it does the opposite. A second favorite asks you to rank tools — open-market operations are the most flexible workhorse, while reserve requirements are the bluntest and rarest (the Fed actually set them to 0% in March 2020, so that tool is now dormant, though exam banks still teach it). Watch the body split: the FOMC directs open-market operations, but the Board of Governors sets the discount rate and reserve requirements.

The classic trap is mixing the actors with fiscal policy — anything involving taxes or government spending is Congress/President, not the Fed. Don’t confuse the discount rate (Fed-to-bank lending) with the federal funds rate (bank-to-bank). Tie it to siblings: tightening lifts the short end and can flatten or invert the yield curve, the recession signal, and the Fed typically eases near a cycle trough and tightens near the peak.