What is monetary policy?


Monetary policy is a key factor that has power to influence the direction of a certain nation’s economy. Actually it determines that what amount of money will flow within the economy. This policy maintains the activities of an economy by controlling the credit and money supply of that particular country. Federal Reserve has ability to control this policy by changing rate of interests and the amount of money that the banks must possess in their reserves. These powers of Federal Reserve have been clearly defined in the Act of 1993 and from the advent of this act the importance of this policy has increased to a great extent.

According to the Federal Reserve Act, the monetary policies are actually designed for the sake of encouraging more employment, stabilizing the prices and moderating the interest rates and it has been observed that when these monetary policies are being implemented rightly then they result in stabilized prices and the wages. This stabilization helps in having an economic growth ultimately. The role of US monetary policy is quite impressive not only in economy but also in the consumer making decisions too. The consumer decisions can be buying a house or a car, expanding their business etc.

Monetary policies are actually determined by the Board of Governors of Federal Reserve system and Federal Open Market Committee. It is necessary to discover the perfect balance while setting this policy. It is a common thinking that monetary policies are similar to the fiscal policies but they are not. These two policies can be used to control the economy but in a detailed context they are separate. Fiscal policies are made by the federal government and they refer to tax and other spending schemes.

Tools of monetary policies?

A Federal Reserve can utilize different tools while setting these monetary policies. These tools include the open market operations, reserve requirements and the discount rate. The FOMC is primarily responsible for the open market operations whereas the discount rates and the reserves requirements are maintained by the Board of governors.

Open market operations are regarded as the most common and flexible way of imposing the monetary policies.  These operations include the selling and buying of the government securities in the open market. When we talk about US banking system, we come to know that in US these operations contract or expand money. When a federal fund rate is low, it motivates the consumer spending due to low interest rates and thus an economy progresses. But when the rate is high then the people get discourage and they spend less so as a result the economy gets slow. When the changes in the federal fund rates occur, they effect the investment and the foreign exchange rates too.

The second tool that is exercised to set this policy is the discount rate. This rate is charged by the Federal Reserve from the other banks on borrowing the money. High rate depicts a restraining policy and the low rate shows an expansive policy. The third tool is known as reserve requirement. This is considered as amount of cash that is required to maintain by all commercial and saving banks, US branches and the agencies of different foreign banks as reserve all the times.


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