15). The Federal Reserve can also influence the ability for commercial banks to lend by manipulating the reserve ratio. The reserve ratio is the amount the Federal Reserve is requiring the banks to keep in their reserve. By increasing or decreasing the reserve ratio, this determines if a bank has more or less money to lend (The Federal Reserve, 2007). In the event that a main bank would have unexpected or immediate needs for additional funds, the Federal Reserve can make short-term loans (McConnell-Brue, 2004, chpt.
The Federal Reserve and Macroeconomic Factors Introduction The Federal Reserve controls the economy of the United States through a variety of tools. They use these tools to shape the monetary policy of the United States in order to promote economic growth and reduce the rate of inflation and the unemployment rate. By adjusting these tools, the Fed is able to control the amount of money in the supply. By controlling the amount of money, the Fed can affect the macro-economic indicators and steer the economy away from runaway inflation or a recession. The Federal Reserve The Federal Reserve uses three main tools in order to control the money supply.
Rapid Economic Growth: The monetary policy effects the economic development by controlling interest rates in the economy and its effect. 2. Price Stability: the price rise leads to inflation. Too much of inflation is harmful that the central bank has to control using these policies 3. Exchange Rate Stability: it is the rate at which the currency is exchanged in terms of any other foreign currency.
Instruments of Monetary Policy: 1.Conventional Instruments: a. Open Market Operations It is an instrument which is incorporated in these policies which incorporates purchasing or selling of securities like bonds, bills, etc. from or to the banks. The RBI offers government securities to decrease the credit supply in the economy and buys government securities to expand or energize credit supply in the economy. b.
Open market operations directly affect the money supply through buying short-term government bonds (to expand money supply) or selling them (to contract it). Benchmark interest rates, such as the LIBOR and the Fed funds rate, affect the demand for money by raising or lowering the cost to borrow—in essence, money's price. When borrowing is cheap, firms will take on more debt to invest in hiring and expansion; consumers will make larger, long-term purchases with cheap credit; and savers will have more incentive to invest their money in stocks or other assets, rather than earn very little—and perhaps lose money in real terms—through savings accounts. Policy makers also manage risk in the banking system by mandating the reserves that banks must keep on hand. Higher reserve requirements put a damper on lending and rein in inflation.
This determines whether the base money that the Fed will release should decrease or increase. As stated in the simulation, the Fed also "tries to use the money supply as a lever to keep the economy on the rails". This is not an easy task for it requires very complicated analysis. Influence on Money Supply There are several factors affecting the money supply: spread between the discount rate and federal funds rate, required reserve ratio and open market operations. It is very important to understand that whenever the "DR charged by Fed is lower than the FFR charge by other banks; banks tend to borrow from the Fed.
Conclusion The Fed uses easy money policy to increase the money supply when real GDP is low and unemployment is high; however, the Fed must keep a watch on inflation because GDP and inflation tends to work in the same direction. Once inflation gets to a certain point, the Fed will use a tight money policy to decrease the money into the system. Controlling the money supply is critical to the economy. Balancing inflation and real GDP plays a major role in the economy. References McConnell & Brue (2004).
Monetary Policy Monetary policy refers to use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit. The goal of monetary policy are achieving specific objectives, such as low and stable inflation and promoting growth. The monetary policy is that wing of economic policy that concern with cost and availability of money in economy is perhaps stating without being informative. In terms of public perception, the way fiscal policy is associated with taxation, monetary policy is perhaps mostly conceived of as interests rate is changes so that one gets more while depositing money in the local bank or pays more while taking a house lone. These actions mostly have to do with commercial banks
If it is lowered, banks are required to keep less money, and so more money is put out into circulation (theoretically). If it is raised, then banks may have to collect on some loans to meet the new reserve requirement. The tool known as open market operations influences money and credit operations by buying and selling of government securities on the open market. This is used to control overall money supply. If the Fed believes there is not enough money in circulation, then they will buy the securities from member banks.
From nominal and real rates there are also lowered and raised rates. When the interest rate is lowered consumer spending grows while savings decrease. Spending on items such as housing becomes one of the ways the AD rises. Though AD rises it pulls the economy out lack of spending, but puts the economy into the possibility of inflation. Differentiating from low rates, high rates stop inflation but creates the possibility of recession.