Open Market Operations & Reserve Requirements

⚠️ MONETARY vs FISCAL POLICY — who controls what

This is the top trap in Unit 3. Every tool on this page belongs to the Federal Reserve, not to Congress or the President.

Policy	Who controls it	Tools
Monetary policy	The Federal Reserve Board (the Fed) — open market operations specifically conducted by the FOMC (Federal Open Market Committee)	🔑 DORM: Discount rate, Open market operations, Reserve requirements, Margin requirements (Reg T)
Fiscal policy	Congress and the President (covered in the Fiscal policy chapter)	Taxation and government spending — none of the DORM tools

If a question names the discount rate, open market operations, reserve requirements, or Regulation T margin requirements, the answer is the Fed, never Congress.

🔑 THE MASTER TABLE — every Federal Reserve tool

“The Federal Reserve has four tools it can use to enforce monetary policy.”

Tool	What it is	Who sets it	TIGHTENING action → effect on money supply & interest rates	EASING (loosening) action → effect on money supply & interest rates
D — Discount rate	“the interest rate the Fed charges when a bank borrows directly from the Federal Reserve” — 🔑 the only rate the Fed controls directly	The Federal Reserve	Raise the discount rate → borrowing from the Fed becomes more expensive → reduces lending → tightens money supply → interest rates up	Lower the discount rate → banks borrow more cheaply → increases lending → loosens money supply → interest rates down for customers
O — Open market operations	“the Fed’s purchases and sales of securities with banks” — the tool the Fed uses most actively	The FOMC (Federal Open Market Committee), a part of the Federal Reserve	Sell securities to banks = reverse repurchase agreements → Fed takes cash out of the system in exchange for securities → less cash available to lend → tightens money supply → interest rates up	Buy securities from banks = repurchase agreements → Fed puts more cash into banks in exchange for securities they own → more cash available to lend → loosens money supply → interest rates down
R — Reserve requirements	“the portion of deposits they must hold in reserve” — banks must continually meet them	The Federal Reserve	Raise reserve requirements → banks must hold more deposits in reserve and can lend out less → decreases money in the financial system (tightening) → interest rates up, borrowing more expensive	Lower reserve requirements → banks can lend out more of their deposits → increases money in the financial system (loosening) → interest rates down, borrowing cheaper
M — Margin requirements (Regulation T)	Reg T “requires investors to deposit 50% of the purchase price for initial margin transactions”	The Federal Reserve	Raise Reg T above 50% → reduces borrowing for investment purposes → decreases the amount of money in the system (tightening) → interest rates up	Lower Reg T below 50% → allows investors to borrow more for investment purposes → expands the money supply (loosening) → interest rates down

Mnemonic: Many test takers remember these four tools by the acronym ‘DORM.’

“Of the four tools, open market operations are the tool the Fed uses most actively.”

The discount rate

“The discount rate is the interest rate the Fed charges when a bank borrows directly from the Federal Reserve.”

“Although the Fed tries to influence interest rates throughout the economy, the discount rate is the only rate it controls directly.”

Fed action	Cost to banks	Lending	Money supply	Interest rates
Lowers the discount rate	Banks can borrow more cheaply	Tends to increase lending	Loosens	Pushes rates down for customers
Raises the discount rate	Borrowing from the Fed becomes more expensive	Tends to reduce lending	Tightens	Pushes rates up

Open market operations

“Open market operations are the Fed’s purchases and sales of securities with banks.”

🔑 Repos vs reverse repos

	Repurchase agreement (repo)	Reverse repurchase agreement (reverse repo)
Fed’s action	Fed BUYS securities from banks	Fed SELLS securities to banks
Why the name	“the bank will buy back the securities at some point in the future”	“This is the opposite of a repurchase agreement” — later, the Fed will buy back the securities
Short-term cash flow	Fed is putting more cash into banks in exchange for securities the banks own (e.g., Treasury bonds)	Fed is taking cash out of the system by exchanging securities for cash
Cash available to lend	More	Less
Money supply	Loosened	Tightened
Interest rates	Decreasing (tend to fall)	Increasing (tend to rise)

Trap: “Fed buys = money supply grows” and “Fed sells = money supply shrinks.” The direction feels backwards to many test takers — the Fed hands out cash when it buys.

The FOMC

Attribute	Detail
What it is	The Federal Open Market Committee (FOMC), a part of the Federal Reserve
Role	Oversees open market operations
Typical securities traded	Treasury / government securities and prime banker’s acceptances (short-term bank securities)
Recent expansion	“In the past decade (especially during the COVID-19 crisis), the securities traded by the FOMC have expanded.”

Exam-relevance note the text makes: > “For exam purposes, focus on what the FOMC typically trades, not the unique securities traded during an economic catastrophe.”

Reserve requirements

As discussed in the Rates chapter, banks must continually meet reserve requirements (the portion of deposits they must hold in reserve). The Fed can raise or lower these requirements to pursue monetary policy.

Real-world footnote: the Fed set reserve requirement ratios to 0% effective March 26, 2020, and they have stayed there — so this is currently a dormant tool in practice (Federal Reserve ). The exam still tests the raise/lower logic below; answer it as written.

Fed action	Bank lending capacity	Money in the financial system	Interest rates	Borrowing cost
Lowers reserve requirements	Banks can lend out more of their deposits	Increases (loosening)	Tend to fall	Borrowing becomes cheaper
Raises reserve requirements	Banks must hold more in reserve, can lend out less	Decreases (tightening)	Tend to rise	Borrowing becomes more expensive

Margin requirements (Regulation T)

Leverage

“When investors use margin, they borrow money to invest. This is called leveraging, and it amplifies both gains and losses.”

Outcome	Result of leveraging
Investment performs well	“the investor can earn more than they would using only their own capital”
Investment performs poorly	“the investor can lose more than they would using only their own money”

🔑 Regulation T

“Regulation T was created to prevent investors from borrowing too much money. It requires investors to deposit 50% of the purchase price for initial margin transactions.”

Memorize: Reg T initial margin = 50%.

Worked example from the text: “if you purchase $10,000 of stock in a margin account, Regulation T requires a deposit of at least $5,000.”

Fed action on Reg T	Investor borrowing	Money supply
Lower Reg T below 50%	Investors can borrow more for investment purposes	Loosens (expands) the money supply
Raise Reg T requirements	Reduces borrowing for investment purposes	Tightens (contracts) — decreases the amount of money in the system

🔑 Final summary — loosening vs tightening actions

“Let’s summarize the actions that correspond with loosening and tightening the money supply”

Tool	Loosening (growing) the money supply	Tightening (shrinking) the money supply
Discount rate	Lower the discount rate	Raise the discount rate
Open market operations	Pursue repurchase agreements (Fed buys)	Pursue reverse repurchase agreements (Fed sells)
Reserve requirements	Lower reserve requirements	Raise reserve requirements
Margin requirements	Lower margin requirements	Raise margin requirements

Pattern to memorize: LOWER everything = loosen (rates down). RAISE everything = tighten (rates up). The single exception in wording is open market operations, where “buy” is the loosening action and “sell” is the tightening action.

Key points

Tools of the Federal Reserve

D - discount rate
O - open market operations
R - reserve requirements
M - margin requirements (Reg T)

Discount rate

Rate for Fed loans to banks
Result of lowering:
- Loosens money supply
- Decreases interest rates
Result of raising:
- Tightens money supply
- Increases interest rates

Open market operations

Fed buys and sells securities
Conducted by the FOMC
Typical securities traded:
- Government securities
- Prime banker’s acceptances

Repurchase agreements

Fed buys securities from banks
Result:
- Loosened money supply
- Decreasing interest rates

Reverse repurchase agreements

Fed sells securities to banks
Result:
- Tightened money supply
- Increasing interest rates

Reserve requirements

Banks must hold a portion of deposits in reserves
Result of lowering:
- Loosens money supply
- Decreases interest rates
Result of raising:
- Tightens money supply
- Increases interest rates

Margin requirements (Reg T)

50% deposit for margin transactions
Result of lowering:
- Loosens money supply
- Decreases interest rates
Result of raising:
- Tightens money supply
- Increases interest rates

Sources

Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.

#	Source	Publisher
1	Open market operations and the federal funds target	Federal Reserve
2	Reserve requirements (set to 0% since March 2020)	Federal Reserve
3	Discount window and the discount rate	Federal Reserve
4	FOMC — composition and meeting schedule	Federal Reserve
5	Achievable Series 65 — chapter 3.1.3	Achievable (course text)

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