conducting monetary policy.pdf - Function Conducting...

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20 Purposes and Functions of the Federal Reserve System Function Conducting Monetary Policy The Federal Open Market Committee sets U.S. monetary policy in accordance with its mandate from Congress: to promote maximum employment, stable prices, and moderate long- term interest rates in the U.S. economy. 3 The Federal Reserve’s Monetary Policy Mandate and Why It Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 How Monetary Policy Affects the Economy . . . . . . . . . . . . . . . . . . . . . . . 27 Monetary Policy in Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Monetary Policy Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
The Federal Reserve System Purposes & Functions 21 hat is monetary policy? It is the Federal Reserve’s actions, as a central bank, to achieve three goals specified by Congress: maximum employment, stable prices, and moderate long-term interest rates in the United States ( figure 3.1 ). The Federal Reserve conducts the nation’s monetary policy by managing the level of short-term interest rates and influencing the availability and cost of credit in the economy. Monetary policy directly affects interest rates; it indirectly affects stock prices, wealth, and currency exchange rates. Through these channels, monetary policy influences spend- ing, investment, production, employment, and inflation in the United States. Effective monetary policy complements fiscal policy to support economic growth. While the Federal Reserve’s monetary policy goals have not changed for many years, its tools and approach to implementing policy have evolved W Figure 3.1. The Federal Reserve’s statutory mandate The Federal Reserve conducts monetary policy in pursuit of three goals set for it by Congress. The three mandated goals are considered essential to a well-functioning economy for consumers and businesses. Traditional monetary policy Nontraditional monetary policy Mandate 1. Maximum employment 2. Stable prices 3. Moderate long-term interest rates Forward guidance Helps the public better understand policymakers’ intentions about the future course of monetary policy Large-scale asset purchases Provide additional stimulus to interest- sensitive spending, affect the economy through the same channels as traditional monetary policy Open market operations Influence supply of balances in the federal funds market, supply of money and credit in the economy Reserve requirements Influence demand for balances in the federal funds market, supply of money and credit in the economy Discount window lending Influences supply of balances in the federal funds market, supply of money and credit in the economy
22 Conducting Monetary Policy over time. Prior to the financial crisis that began in 2007, the Federal Reserve bought or sold securities issued or backed by the U.S. govern- ment in the open market on most business days in order to keep a key short-term money market interest rate, called the federal funds rate, at or near a target set by the Federal Open Market Committee, or FOMC ( figure 3.2 ). (The FOMC is the monetary policymaking arm of the Fed- eral Reserve.) Changes in that target, and in investors’ expectations of

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