In this paper, I will identify the three monetary tools used by the Federal Reserve. In addition, I will explain how these monetary tools influence the money supply and in turn affect macroeconomic factors. Next, I will explain how money is created. Lastly, I will recommend monetary policy combinations that best achieve a balance between economic growth, low inflation, and a reasonable rate of unemployment. Tools Used by the Federal Reserve to Control the Money Supply The three monetary tools used by the Federal Reserve to alter the reserves of commercial banks are: Open-market operations, reserve ratio, and the discount rate (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.
Increasing interest rates and selling securities via open market operations is common one. They use expansionary monetary policy to minimize unemployment and avoid the recession. They bring down the interest rates, purchase securities from member banks, and use other ways to raise the liquidity. There are two types of the monetary policy such as: A. Quantitative measures: Are designed to adjust the volume of credit created by the banking system. It is work through affecting the demand and supply of credit.
Monetary policy is the method by which the government, central bank, or monetary authority controls the supply of money, or trading foreign exchange markets. This policy is usually called either an expansionary policy, or a contractionary policy. An expansionary policy multiplies the total supply of money in the economy, and a contractionary policy diminishes the total supply. Expansionary policy is used to tackle unemployment in an economic decline by lowering interest rates, while contractionary policy has the goal of elevating interest rates to fight inflation. Monetary policy reposes on the relationship between the rates of interest in an economy and the total dispense of money.
It is the primary tool used by Fed to influence the supply of bank reserve. When Fed wants to increase reserve, it buys securities, and when it wants to decrease reserve, it sells them. Discount Rate, it is in fact, the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank 's lending facility, (Board of Governors Federal Reserve System, n d). The financial institutions must borrow funds at this interest to the Federal Reserve System. Fed use this tool to control the supply of money something that will affect the inflation and the overall interest rates.
The Fed can use three tools to set their monetary policy. The tools work by changing the amount of excess reserves in the banking system (McConnell, Brue 2004). Conducting open-market operations (the buying and selling of government bonds to the public and banks), changing the reserve ratio (percentage of commercial bank deposit liabilities required as reserves) and changing of the discount rate (McConnell, Brue 2004). The Fed utilizes the open-market operations and changing of the discount rate the most. GDP can be expressed in two general ways: as the value of output by summing all expenditures on that output (Expenditure Approach) or by (Income Approach) adding up all the components of income arising from the production of that output (McConnell, Brue 2004).
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 the most important tool is the open-market operations. The open-market operations deal with buying or selling government bonds to commercial banks or to the public. When the Fed buys bonds from commercial banks, the commercial bank will have negative securities and positive reserves in assets. The positive reserves will increase the lending ability of the commercial banks.
The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. State of the Economy is apart from the geopolitical and other uncertainties; the forces affecting demand this year appear, on balance, conducive to a moderate strengthening of the economic expansion.
Monetary Policy I chose to research and write on the topic of monetary policy. My two main sources of information were www.federalreserve.gov and www.frsbf.org. From my research I would define monetary policy as the macroeconomic act of keeping the country financially stable. According to www.frsbf.org “The object of monetary policy is to influence the performance of the economy as reflected in such factors as inflation, economic output, and employment. It works by affecting demand across the economy—that is, people's and firms' willingness to spend on goods and services”.
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.