The Economy and Monetarty Policy

In principle, could the Federal Reserve conduct monetary policy through the purchase and sale of stocks on the New York Stock Exchange? Do you see any possible drawbacks to such a policy?

“In open market purchases, the Federal Reserve buys government bonds from the private sector” (O’Sullivan & Sheffrin, 2006, 646). This increases the money supply. “Each bank must keep an account with the Fed containing both its required and excess reserves. The check written against the Federal Reserve increases the bank’s total reserves, essentially giving it more money to loan out” (O’Sullivan & Sheffrin, 2006, 647).

“In open market sales, the Federal Reserve sells government bonds to the private sector” (O’Sullivan & Sheffrin, 2006, 646). Open market sales will decrease the money supply. If the Federal Reserve sells government bonds to someone, that person will pay for the bonds with a check drawn on his or her bank and give this check to the Federal Reserve. The bank must either hand over the money in cash or reduce its total reserves with the Federal Reserve by that amount (O’Sullivan & Sheffrin, 2006).

Although bond interest rates are usually low, they are safe in promising to pay some money in the future. “If you own a bond, you are entitled to receive payments on it at a later time” (O’Sullivan & Sheffrin, 650).

This means of monetary policy would be achievable in the New York Stock Exchange. The government could sell stocks to the private sector, therefore, decreasing the money supply. The government could also buy stocks from the private sector, therefore, increasing the money supply.

Although it is achievable for the government to do this, there would be drawbacks to this situation. The stock market is not always stable. It rises and falls daily, sometimes by large amounts. This would potentially lead to a large loss of money for our government.

The stock market could also crash. “The most famous crash, the Stock Market Crash of 1929, started on October 24, 1929 (known as Black Thursday), when the Dow Jones Industrial Average dropped 50%. This event preceded the Great Depression” (Wikipedia, 2005, 2).

“It started on October 24and reached its peak on October 29, 1929 (“Black Tuesday”) when share prices on the New York Stock Exchange collapsed. However, the days leading up to the 29th had also seen enormous stock market upheaval, with panic selling and vast levels of trading interspersed with brief periods of recovery” (Wikipedia, 2005, 1).

If the stock market were to get in another mess such as this, the government may be stuck with worthless stocks that they can not sell. This would cash a crash in our economy. They could also be forced to sell expensive stock for big losses.

The stock market has seen more than one crash in its history, and it is feasible that there will be many more to come in the future.

Suppose the Federal Reserve purchased gold or foreign currency. How would this purchase affect the domestic money supply?

“The basic rule of the gold standard was a fixed amount of gold for each specific weight of gold. Paper currencies were redeemable into gold at any time. A nation’s monetary reserves consisted of only gold. On an international level,