Introduction to the FOMC. The Fed and the Dual Mandate. The Fed Implements Monetary Policy. Expansionary and Contractionary Policy. Gathering Data. Supervision and Regulation: An Introduction.
Safety and Soundness. Consumer Protection. Discount Window Lending. Term Auction Facility. Financial Services. Providing Financial Services. Electronic Forms of Payment. Independence and Accountability. Online Learning Module. The discount rate is the interest rate charged by Federal Reserve Banks to depository institutions on short-term loans. Reserve requirements are the portions of deposits that banks must maintain either in their vaults or on deposit at a Federal Reserve Bank.
The Fed uses open market operations as its primary tool to influence the supply of bank reserves. This tool consists of Federal Reserve purchases and sales of financial instruments, usually securities issued by the U.
Treasury, Federal agencies and government-sponsored enterprises. The transactions are undertaken with primary dealers. When the Fed wants to reduce reserves, it sells securities and collects from those accounts. Most days, the Fed does not want to increase or decrease reserves permanently, so it usually engages in transactions reversed within several days.
By trading securities, the Fed influences the amount of bank reserves, which affects the federal funds rate, or the overnight lending rate at which banks borrow reserves from each other. The federal funds rate is sensitive to changes in the demand for and supply of reserves in the banking system, and thus provides a good indication of the availability of credit in the economy. At each meeting, the committee discusses the outlook for the U. Governors and Reserve Bank presidents including those currently not voting present their views on the economic outlook.
The FOMC members then discuss their policy preferences. Finally, the FOMC votes. Monetary policy is the process by which the monetary authority of a country controls the supply of money with the purpose of promoting stable employment, prices, and economic growth. Monetary policy can influence an economy but it cannot control it directly.
There are limits as to what monetary policy can accomplish. Below are some of the factors that can make monetary policy less effective. While monetary policy can influence the elements listed above, it is not the only thing that does. Fiscal policy can also directly influence employment and economic growth. If these two policies do not work in concert, they can cancel each other out.
This is an especially significant problem when fiscal policy and monetary policy are controlled by two different parties. One party might believe that the economy is teetering on recession and may pursue an expansionary policy. The other group may believe the economy is booming and pursue a contractionary policy. The result is that the two would cancel each other, so that neither would influence the direction of the economy.
A liquidity trap is a situation where injections of cash into the private banking system by a central bank fail to lower interest rates and therefore fail to stimulate economic growth. Usually central banks try to lower interest rates by buying bonds with newly created cash. In a liquidity trap, bonds pay little to no interest, which makes them nearly equivalent to cash.
Under the narrow version of Keynesian theory in which this arises, it is specified that monetary policy affects the economy only through its effect on interest rates. Thus, if an economy enters a liquidity trap, further increases in the money stock will fail to further lower interest rates and, therefore, fail to stimulate.
This is a liquidity trap. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.
Deflation is a decrease in the general price level of goods and services. This should not be confused with disinflation, a slowdown in the inflation rate. Inflation reduces the real value of money over time; conversely, deflation increases the real value of money. This allows one to buy more goods with the same amount of money over time.
The velocity of money is the frequency at which one unit of currency is used to purchase domestically-produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time.
If the velocity of money is increasing, then more transactions are occurring between individuals in an economy. Deflation is a problem in a modern economy because it increases the real value of debt and may aggravate recessions and lead to a deflationary spiral.
If monetary policy is too contractionary for too long, deflation could set in. Inflation targeting occurs when a central bank attempts to steer inflation towards a set number using monetary tools.
Because interest rates and the inflation rate tend to be inversely related, the likely moves of the central bank to raise or lower interest rates become more transparent under the policy of inflation targeting. Examples include:. Under the policy, investors know what the central bank considers the target inflation rate to be and therefore may more easily factor in likely interest rate changes in their investment choices.
This is viewed by inflation targeters as leading to increased economic stability. Instead of setting a specific number, the Fed sets a target range. Strictly or blindly adjusting interest rates will potentially be ineffectual and restrict economic growth when it was not necessary to do so.
It has been argued that focusing on inflation may inhibit stable employment and exchange rates. Supporters of a nominal income target also criticize the tendency of inflation targeting to ignore output shocks by focusing solely on the price level. They argue that a nominal income target is a better goal. Privacy Policy. Skip to main content. Monetary Policy. Search for:.
Impacts of Federal Reserve Policies. Learning Objectives Recognize the impact of monetary policy on aggregate demand. Key Takeaways Key Points Aggregate demand AD is the sum of consumer spending, government spending, investment, and net exports. The AD curve assumes that money supply is fixed. The decrease in the money supply will lead to a decrease in consumer spending. This decrease will shift the AD curve to the left.
The increase in the money supply will lead to an increase in consumer spending. This increase will shift the AD curve to the right.
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