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If the economy is facing a downturn, there are three general things that the Federal Reserve can do to try to improve the situation.
The Federal Reserve is in charge of monetary policy for the United States. Monetary policy has to do with manipulating the supply of money to either boost the economy or slow it. In this case, the economy is not doing well enough so the Fed (the usual abbreviation for the Federal Reserve) will need to loosen up the supply of money. It will want to increase the supply of money that is available. If more money is available, more consumers and businesses will borrow and spend money. This will increase economic activity and, hopefully, get the economy out of its slump.
There are three things the Fed can do. First, it can lower the required reserve ratio. This would let the banks loan more of the money that they take in. This is not a very effective policy and is not usually used. Second, the Fed can reduce interest rates. This would make the cost of borrowing lower and would encourage borrowing. The Fed often does this in economic downturns. Finally, the Fed can engage in “open market operations.” In this case, it will buy government securities from banks. This will pump money into the banks and encourage lending.
These are the three forms of expansionary monetary policy that the Fed can engage in.
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