Answer to Question 1
In order to lower the rate of inflation using monetary policy, the central bank of Greatland needs to raise the rate which banks charge each other for overnight loans, called the federal funds rate. This can be done using four different tools. First, the central bank can reduce the quantity of bank reserves by using open market operations. Second, it can increase the reserve requirement. Third, it can increase the interest rate that it pays on reserves. Fourth, it can increase the discount rate. All of these policies will increase the federal funds rate and have a related effect on the interest rates that households and firms face for borrowing. Consequently, a rise in the federal funds rate reduces the rate of loan growth to households and firms, reducing the rate at which the money supply grows, and reducing the rate of inflation.
Answer to Question 2
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