The effectiveness of the monetary policy of the Federal Reserve.
Our nation's central bank, known as the Federal Reserve, is responsible for conducting the US monetary policy. One of the main responsibilities includes regulating the money supply in order to keep production, prices, and employment stable. In order to manipulate the money supply, the Federal Reserve uses three tools: the reserve requirement, open market operations, and the discount rate.
Reserve requirements are percentages of deposits that banks may not lend and must hold as vault cash or on deposit at a Federal Reserve Bank. In other words, it is the money that the bank is not allowed to loan out. Therefore, reserve requirements represent a cost to the banking system. There is a continual flow of reserves among banks, which represents the ever-changing supply and demand for these reserves at individual banks.
Open market operations influence money and credit operations by buying and selling of government securities in the open market. When the Federal Reserve engages in open market operations, they are able to influence short-term interest rates and reach other monetary policy targets. This is used to control overall money supply. If the Federal Reserve believes there is not enough money in circulation, then they will buy the securities from member banks. If they believe there is too much money in the economy, they will sell the securities back to the banks.
Lastly, when member banks want to raise money, they can borrow from Federal Reserve Banks. Just like other loans, there is an interest rate, or a discount rate, which is the third tool of the monetary policy. If the discount rate is high, then fewer banks will be tempted to borrow, and if it is low, more banks will borrow from the reserve banks.
These tools are all good ways to influence the money supply, however, as with anything, the monetary policy has its strengths and weaknesses.
