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Therefore, the reserve requirement is affected by the nature of both fed fund rate and feds discount rate. Also, the quantity demanded of reserve is determined by its price (interest rate) in the fed fund market.
The quantity demanded increases with a decrease in interest rate and vice versa. In this regard, central banks can, therefore, affect the demand for reserves of commercial banks just by changing reserve requirement. Unlike other monetary tools, the impact of changes of reserve requirement is spread evenly across all banks to bring about neutrality. Changes in the reserve requirement tend to induce all banks to adjust their balance sheets rapidly. However, the reserve requirement is nowadays limited due to current sweep accounts and other loopholes of reserve requirement. Today central banks rarely use reserve requirement as the monetary policy tool because most banks operate around it (Thomas 418).
The open market operate under the monetary base; that is, MB = C + R. Open market operations are preferable by most central banks because they can help to expand or contract monetary base to a precise level. With the use of open market operations, the central bank can reverse mistakes quickly because they are under its control. Open markets operations help to support the discount policy rate especially when there are excessive reserves. In the United States, Fed moves the equilibrium rate by use of open market operations toward the target established by the federal committee of open market operations. In addition, Fed can add reserves to the system by buying assets such as Treasury bond and can remove them from the system by selling these assets. Therefore, the central bank sells assets to increase the money base as well as the money supply in the system and vice versa. The central bank conducts open market operations to get the interbank lending rate near its target. Unlike other monetary tools, OMO lack announcement effect because they are
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