There are 12 Federal Reserve Banks that make up the central bank in the United States of America. These 12 banks are also known as the Fed. The Fed has three monetary policy tools that they can use to control the money supply. They are open market operations, reserve ratio and discount rate. These three tools used by the Fed have an impact on gross domestic product (GDP), inflation, interest rates and unemployment. Open Market Operations The Fed's most important tool is open market operations. Open market operations involve the buying or selling of government bonds to commercial banks or the public. When the Fed purchases bonds from commercial banks, the commercial bank will have negative securities and positive reserves in assets. Positive reserves will increase the lending capacity of commercial banks. The commercial bank will have positive reserves in assets and positive controllable deposits in liabilities and equity, when the Fed purchases bonds from the public. Buying bonds from the public is similar to buying bonds from commercial banks. Both increase the lending capacity of commercial banks. The opposite will happen when the Fed sells government bonds to commercial banks. The commercial bank will have a positive value for securities and a negative value for reserves in assets. Negative reserve in assets will reduce the lending capacity of commercial banks. The Fed selling to the public will cause the same result as selling to commercial banks. Commercial banks will have negative reserves in assets and negative controllable deposits in liabilities and equity. Commercial banks and the public are willing to buy or sell government bonds to the Fed depending on the price of the bonds and their interest... middle of the paper... simulations are run to increase and decrease the money. in the monetary policy control system. The simulation shows how controlling the money supply impacts the economy. Creating the right balance between GDP and inflation is crucial for the economy. Conclusion The Fed uses accommodative monetary policy to increase the money supply when real GDP is low and unemployment is high; however, the Fed needs to keep an eye on inflation because GDP and inflation tend to run in the same direction. Once inflation reaches a certain point, the Fed will use restrictive monetary policy to decrease the inflow of money into the system. Controlling the money supply is critical to the economy. Balancing inflation and real GDP plays an important role in the economy. References McConnell & Brue (2004). Economy: principles, problems and policies. New York: The McGraw-Hill Companies.