Monetary policy is what the Federal Reserve uses to influence the amount of money and credit in the United States economy. The goal of monetary policy is to promote a stable economy by promoting maximum employment, moderating long-term interest rates and stabilizing prices. There are three instruments of monetary policy that the Federal Reserve uses; open market operations, the discount and federal funds rates and the reserve requirements. I am going to define each of these instruments and explain how the Federal Reserve uses each of them to control the supply of money.
The first tool the Federal Reserve uses is open market operations (OMO) to influence the supply of bank reserves. OMO's are when the Federal Reserve decides to buy or sell government bonds on the open market so that it can increase or decrease the amount of money and interest rates in the banking system. OMO's are effective at controlling the supply of money when it comes to short-term rates and inflation. In order to control a recession and increase GDP, the Federal Reserve buys bonds. When they buy bonds, there is a release of funds into the economy. Since the banks have more money to lend, the interest rates will fall, in turn giving people more money to spend in the consumer-based economy. This helps people find jobs and more people will spend so a recession can be controlled. On the other hand, the Federal Reserve can control inflation by selling bonds. This will decrease the money supply, lead to higher interest rates and decrease spending. If the prices for food and commodities fall, it may help reduce inflation. Currently, the unemployment rate is steadily dropping and inflation seems to be consistent at a 2% rate. The Federal Reserve should continue to conduct open market operations during the week by buying and selling to maintain the current economic situation.
The next tool used by the Fed is the federal funds rate and discount rate.
