25. How does monetary policy support the economy?

How does monetary policy affect the economy? Explain the fundamentals behind why changes in the money supply have real effects on the economy and the monetary transmission mechanism. Explain how monetary policy can be used to effectively stabilize output and smooth business cycles. Evaluate the role of monetary policy and how it affects the macroeconomy given the implications of the financial accelerator.

A.

Describe the various instruments of monetary policy and how they are used.

B.

Through what channels does monetary policy affect the economy? That is, what are the monetary policy transmission mechanisms? List first them, then clearly describe two of these channels.

The U.S. Federal Reserve is the central bank of the United States. It has many roles in the economy, but one of its key roles is conducting monetary policy.

1. What is monetary policy?
2. Suppose the Fed wants to close an inflationary gap. How could it use each of the three tools of monetary policy to close the gap? 
3. Using the monetary policy tool the Fed employs most often, the Fed closes an inflationary gap. Describe the steps the economy goes through to move to the new equilibrium output and price level. Use graphs with your answer and be sure to label everything completely.