Final answer:
The FRB affects the money supply using three policy tools: open market operations, reserve requirements, and the discount rate. These tools impact economic activity by influencing bank reserves and the federal funds rate.
Step-by-step explanation:
The Federal Reserve Board (FRB) uses three main policy tools to affect the money supply (Ms) and conduct monetary policy:
Open market operations: This involves the buying and selling of U.S. Treasury bonds. When the Fed buys securities, it increases the reserves of the banking system, thus increasing the money supply; conversely, when it sells securities, it decreases reserves and the money supply. The target of these operations is the federal funds rate—the rate that banks charge each other for overnight loans.
Reserve requirements: These are the regulations on the minimum amount of reserves a bank must hold against deposits. Lowering reserve requirements leaves banks with more funds to lend out, thus growing the money supply; increasing the reserve requirements has the opposite effect.
Discount rate: This is the interest rate the central bank charges commercial banks for short-term loans. Lowering the discount rate makes it cheaper for banks to borrow funds, which can lead to an increase in the money supply; raising the discount rate has the reverse effect.
These tools impact aggregate demand and influence the level of economic activity, playing a crucial role in the Fed's mandate to promote stable prices and full employment.