Role of Federal Reserve in Economic Policy

The economic policy adopted by the Federal Reserve seeks “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates” (Federal Reserve website). This has considerable influence on the economic growth of the country in terms of increased productivity, creation of employment opportunities, controlling inflation, guiding efficient allocation of resources, and higher standards of living. The measures are effective in controlling inflation promoting savings in households and investment in businesses.

These are the goals and objectives of the economic policy adopted by the Federal Reserve. The Federal Reserve does not directly control inflation or employment. Instead it uses indirect means of controlling the market forces through the raising or lowering of short-term interest rates. This is implemented through open market operations and the discount rate applied on the bank reserves. Monetary policy control is implemented through the control of the federal funds rate that is the rate at which the depository institutions trade balances with the Federal Reserve.

The institution operates through the manipulations in open market operations involving the purchase or sale of securities, and the percentage of deposits that the Federal Reserve Bank requires to hold in the form of cash or any account. The Federal Reserve exercises control over the financial market through the lowering or raising the amount of deposit that the depository institutions hold with the Federal Reserve Bank in addition to the reserve balance.

Another means of controlling and monitoring the financial market is through the extension of credit to depository institutions made through primary, secondary, or seasonal lending programs. Changes in short-term interest rates are indicative of long-term interest rate trends likely on treasury notes, corporate bonds, fixed rate mortgages, and auto and other consumer loans. Changes in long-term interest rates have subsequent impact on the market stock prices thus affecting household wealth.

It also has serious impacts on the currency rates since rising interest rates will bring higher yields on dollar assets that will raise the value of dollar in the foreign exchange market. This lowers the cost of imports and raises the price of exports. The chain of reactions affects all aspects on economic activity within the country and subsequently the international market too. In the instance of slowing down of the economy the policy makers will ease the monetary policy to increase market demand.

Increase in market demand will boost productivity and the economic slump will give way to increased employment opportunities thus balancing the economic growth. Similarly inflationary trends can be countered by tightening the monetary policy to reduce the aggregate market demand till the inflation is under control. Thus the monetary policies adopted and exercised by the Federal Reserve act as a cushion against economic imbalances. But the key to implementing such measures lie in the accuracy of factual data and projected market trends that may not present a correct picture at all times.