Monetary policy has some basic goals: to promote "maximum" sustainable output and employment and to promote "stable" prices. The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals. The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy.
The Fed can not control inflation or influence output and employment directly; instead, it affects them indirectly, mainly by raising or lowering a short-term interest rate called the "federal funds" rate. The Federal Reserve has certain tools at its disposal to control monetary policy, open market operations, the discount rate, and reserve requirements. 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 these 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. The point of implementing policy through raising or lowering interest rates is to affect people's and firms' demand for goods and services. Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables. This shows how policy actions affect real interest rates, which in turn affect demand and ultimately output, employment, and inflation.
Monetary policy can be quickly altered and can affect money supply and... [continues]
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