Final answer:
To ease a period of severe deflation, the Federal Reserve could buy government securities, decrease the reserve requirement, and typically would not increase the discount rate as that could worsen deflation. These actions affect the money supply and economic stability.
Step-by-step explanation:
If the United States economy is experiencing a period of severe deflation, the Federal Reserve could take several actions to ease this problem:
- Buy government securities/bonds (Option A): This is part of the open-market operations tool, where the Fed purchases government securities to inject money into the banking system, thereby increasing the money supply and encouraging lending and investment.
- Decrease the reserve requirement (Option C): By lowering the reserve requirement, the Federal Reserve allows banks to lend a larger portion of their deposits, which increases the money supply in the economy and stimulates economic activity.
- The option to increase the discount rate (Option B) would typically be used in the opposite scenario, where the Fed wants to reduce inflation by making borrowing more expensive for banks, thus reducing the money supply. Therefore, it would not be appropriate to ease a deflation problem.
By understanding the basic tools the Federal Reserve uses to implement U.S. monetary policy, such as reserve requirements, discount rates, and open-market operations, we can see how these actions directly affect the nation's money supply and economic stability.
Moreover, the role of the U.S. dollar in trade in the world market has evolved since departing from the gold standard in 1971 and is affected by Federal Reserve policies that can devalue or strengthen the currency in the global market.
During times of economic stress, such as the Great Recession, the Federal Reserve has the option to utilize these monetary policy tools to stimulate the economy, even when fiscal policy is constrained. This is essential for managing the economy when traditional methods reach the lower bound of effectiveness.