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Federal Reservce And Monetary Policy Essay

930 words - 4 pages

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 ...view middle of the document...

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...

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