Final answer:
The Fed utilized the federal funds rate and open market operations as key monetary policy tools before the financial crisis, adjusting interest rates to influence economic stability and engaging in security purchases to control longer-term interest rates.
Step-by-step explanation:
Before the financial crisis of 2007-2009, the Federal Reserve (the Fed) relied on several monetary policy tools to manage the economy. One primary tool was the federal funds rate, which the Fed adjusted to influence economic activity.
During Episodes 7 and 8, the Fed implemented a loose monetary policy, reducing the federal funds rate from 6.2% in 2000 to 1.7% in 2002, and subsequently to 1% in 2003. This action was taken due to concerns about deflation similar to that experienced in Japan.
When the economy started to recover, and the unemployment rate declined in 2004, the Fed began to increase the federal funds rate, reaching 5% by 2007. Additionally, the Fed engaged in open market operations purchasing long-term securities to exert downward pressure on longer-term interest rates and support economic activity.