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Federal Reserve Monetary Policy Essay

1069 words - 5 pages

Federal Reserve Monetary Policy

University of Phoenix
31 July 2009

Federal Reserve Monetary Policy

Money is accepted for payment or transfer of wealth from one person to another in trade for goods and services. Money has three functions in an economy; medium of exchange, a unit of account, and store value. These functions collectively separate money from other assets in the economy, such as stocks, bonds, real estate, and even baseball cards (Mankiw, 2007).
A medium of exchange is an item received for goods and services from buyer to seller. What should a medium of exchange possess? It should be transportable and divisible, have high market value in relation ...view middle of the document...

The central bank for the United States is the Federal Reserve Bank (the Fed) which manages our nation’s banking systems and regulates the amount of money in circulation by setting monetary policies. The Fed attempts to balance the economy by keeping prices steady, workers employed and manufacturers producing goods in three ways: open market operations; discount rate, and the regulation of the amount of reserves that banks must maintain on hand.
The Federal Open Market Committee (FOMC) meets every six weeks to review the economic conditions of the open mark operation to see how loose or tight they want monetary policy. The FOMC has the power to create money out of nothing by purchasing and selling US government bonds on the open market. If the FOMC decides to increase the money supply, the Fed creates dollars and uses them to buy government bonds from the public in the nation’s bond markets (Mankiw, 2007). If the Fed wants to decrease amount of money in circulation they sell government bonds in the open market, tightening credit conditions. The economy is affected by the Federal Reserve Bank’s increase and decrease in the amount of money in circulation.
The discount rate is the interest rate the Fed charges on loans made to banks. To encourage or discourage banks to borrow money, the Fed increases or decreases the rate, changing the amount of money in circulation. When the discount rate is decreased, banks are encouraged to make loans to consumers. This encourages people to borrow money from the banks at lower interest rate creating a surplus of money in the economy.
The reserve requirement is the amount of funds a bank must hold in reserve against deposits rather than loaning it out; the Federal Reserve Bank holds these funds. The amount of reserve funds the Federal Reserve Bank holds depends on the bank’s liabilities. If a bank does not have enough reserve funds, it has to cut back on lending money until they meet the requirement. These three monetary tools help the Federal Reserve Bank determine its monetary policy.
As the US economy tries to stay alive, the monetary policy is to stimulate the economy so people can retain their jobs and...

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