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The federal reserve system, often referred to as the fed, has various tools at its disposal to influence the economy and achieve its dual mandate of promoting maximum employment and maintaining stable prices, which is controlling inflation.
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Here are three basic tools that the fed uses for this purpose.
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Open market operations, or omo.
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Open market operations are the most commonly used and powerful tool in the fed's toolkit.
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It involves the buying and selling of government securities, usually treasury bonds, in the open market.
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And when the fed wants to increase the money supply and stimulate economic activity, it buys government securities from banks and other financial institutions.
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This puts money into their reserves, which allows them to lend more to businesses and consumers, thus reducing interest rates.
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On the other hand, when the fed wants to reduce the money supply and cool down the economy to control inflation, it sells government securities, taking money out of circulation and raising interest rates...