Federal_Reservce_and_Monetary_Policy

Running head: FEDERAL RESERVE MONETARY POLICY Federal Reserve Monetary Policy Aurora Julian University of Phoenix Principles of Economics Cristina Marine April 3, 2010 Federal Reserve Monetary Policy Monetary Policy is established by the Federal Reserve Bank. The Federal Reserve Bank controls the value and strength of money, which is used to purchase goods and services. Understanding how the central bank manages the nation’s monetary policy allows us to see how the Federal Reserve uses their tools to maintain and control monetary policy. The Federal Reserve Bank is consistently reviewing our economic stability and making necessary changes to the monetary policy in an effort to stabilize funds and promote economic growth. The Federal Reserve has recently taken specific actions to help rebuild our current economic strength, which was established in their most recent monetary policy report to the Congress. The purpose of money is to purchase goods and services between people. A monetary value is assessed to goods and services and money functions as a way for people to purchase these goods and services. In the United States our currency is the dollar. The value of the dollar is determined by the Federal Reserve Bank. The Federal Reserve determines whether to increase or decrease the value of money based on certain economic factors. Our monetary policy refers to the actions undertaken by a central bank, which is the Federal Reserve Bank. According to the Federal Reserve, one of their main functions is to “influence the availability and cost of money and credit to help promote national economic goals” (Monetary Policy, para. 1). The Fed became responsible for setting monetary policy in 1913 after the Federal Reserve Act of 1913. There are three tools of monetary policy that Fed is responsible for controlling, open market operations, the discount rate, and reserve requirements. The purpose of these three tools is to allow the Federal Reserve to control supply and demand of the balances in the depository institutions hold at the Federal Reserve Banks, which alters the federal funds rate. The federal funds rate is the interest rate the depository institutions lend funds at the Federal Reserve to other depository institutions overnight (Monetary Policy, para. 2). The most recent actions taken by the Federal Reserve have been to support the financial market functioning, which have led to a rapid expansion of the Federal Reserve’s balance sheet (Insert Caption). Before the financial crisis began in 2007, the Federal Reserve’s balance sheet was less than $900 billion to about $2.3 trillion currently (Monetary Policy Report to the Congress, p.39). The reason for the increase in the Federal Reserve’s balance sheet is due to the increase in the quantity of reserve balances held by depository intuitions. The Federal Reserve is tightening up monetary conditions to prevent inflation pressures. “In October 2008, Congress gave the Federal Reserve statutory authority to pay interest on banks’ holdings of reserve balances at Federal Reserve Banks” (Monetary Policy Report to the Congress, p.39). The idea behind increasing the interest rate paid on reserves is to put pressure on short-term interest rates, yet banks will not supply short-term funds below what they can earn so the banks would leave the funds on deposit at the Federal Reserve Banks. The Federal Reserve utilizes their tools stabilize the economy. To show monetary restraint the Federal Reserve has the option to redeem or sell securities. The effect of a reduction in securities holdings would reduce the quantity of reserves in the banking system and it would also reduce the size of the Federal Reserve’s balance sheet. According to the Monetary Policy Report to Congress, at this time the Federal Reserve hasn’t anticipated that it will sell any of its securities holdings in the near term. Once policy tightening has gotten underway and the economy is clearly in a sustainable it may be revisited (Monetary Policy Report to the Congress, p.39). It is anticipated that the labor market conditions will improve slowly over the next several years. The projected average unemployment rate in the fourth quarter of 2010 is 9.5 to 9.7%, which are slightly below last year’s levels of 10 % (Monetary Policy Report to the Congress, p.45). The consensus of future economic activity and unemployment is subject to greater-than-average uncertainty. According to the monetary policy report, it is believed that the risk of continued deteriorating performance of commercial real estate could adversely affect the still-fragile state of the banking system and restrain the growth of output and employment overcoming quarters. We have established the value of money, which is used to purchase goods and services in our economy. Monetary policy allows us to see how the Federal Reserve uses their three tools; open market operations, the discount rate, and reserve requirements to maintain and control monetary policy in line with the actions taken by the central bank. By consistently reviewing our monetary policy and making necessary changes, the Federal Reserve Bank can stabilize funds and promote economic growth. In light of the recent actions The Federal Reserve has taken to help rebuild our current economic strength, it appears it will take time to improve our economic conditions even in times of uncertainty. Reference  Federal Reserve Bank. (2010).  Board of Governors of the Federal Reserve System. Retrieved from http://www.federalreserve.gov/ Federal Reserve Bank. (2010). Board of governors of the Federal Reserve System. Retrieved from http://www.federalreserve.gov/monetarypolicy/fomc.htm