Just as we repair a car, pliers, hammers, and wrenches, each have their own roles to play.

When the Fed implements monetary policy, it also has several tools to respond to different economic situations.

Today, let's look at the Fed's monetary policy toolbox.

Three conventional tools

The first key tool is Open Market Operations (OMOs).

It means that the Fed trades U.S. Treasuries and other securities to adjust the money supply.

It could help to achieve the goal of raising or lowering interest rates.

When the Fed wants to increase the money supply, the Open Market Trading Desk at the New York Fed purchases securities.

And then, the money paid would flow into the market to support economic activity and create jobs.

Suppose the Fed sells off the U.S. government bonds in the market.

In that case, the Fed collects the trading counterparties' money for purchases.

So there is less money circulating in the market.

Following is the second conventional tool.

The discount window is the Fed facility that offers domestic depository institutions short-term loans, and the interest rates charged are discount rates.

For example, when many people rush to withdraw simultaneously, banks may face heavy pressure.

At the time, the Fed can serve as the "Lender of last resort" to support the liquidity and stability of the banking system.

A lower discount rate would encourage banks to borrow money from the Fed.

And then banks would be more likely to lend more money to consumers, increasing money in circulation.

The third conventional tool is Reserve Requirements.

Banks used to keep a certain number of reserves in the Fed.

But when the Fed wants to increase liquidity, it may lower reserve requirements.

In March 2020, the Fed reduced the reserve requirement ratios to 0%.

Unconventional tools

In addition to these common tools mentioned above, the Fed has various unconventional tools.

Examples include Interest on Reserve Balances, Overnight Reverse Repurchase Agreements Facility, and Money Market Mutual fund Liquidity Facility.

These tools also impact banks, money market funds, and other institutions, ultimately adjusting the money supply.

The financial crisis of 2007–2008 was followed by a severe recession.

The Fed used open market operations to cut the federal funds rate to near zero.

To provide more liquidity to the financial system, the Fed also purchased large amounts of assets and opened a series of special lending facilities.

In addition, given the influence of the dollar in the world, and to coordinate the liquidity of the international market, the Fed also has corresponding facilities to support offshore dollar liquidity.

The Federal Reserve lists more than a dozen tools on its official website.

We grouped them into three categories that we discussed:

Conventional and unconventional tools in the U.S. and supporting offshore U.S. dollar liquidity tools.

When knowing what tools the fed used, we can speculate what may happen in the market.