The Federal Reserve System, known as the Fed, serves as the principal monetary authority of the United States of America. It was established by the Act of Congress in 1913 and structured to be independent of the government, which means that those who are in the position to control the Monetary Supply is autonomous to those who make laws for the nation’s spending but it also liable to government audits and reviews. Monetary Policies are made by The Fed’s FOMC (Federal Open Market Committee) which are composed of mostly Reserve Bank Presidents (FRBSF, 2006).
According to the Federal Reserve Board, “The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals. ” The three tools of monetary policy; the open market operations, the discount rate and the reserve requirements, are also controlled by the Federal Reserve System. Open Market operation involves government bonds that are made available to the public by means of buying and selling, which are also controlled by the Fed.
Monetary policy is powerful in influencing the economic output and people’s decision making because it dictates short-term interest rates, by raising or lowering interest rates. Through interest rates, the government can control output in a way it wants in maintaining economic stability and inflation rate. It is also used by the Fed to manipulate money supply – whether to increase it, known as the expansionary, or shrink, known as the contractionary. Reserve requirements deal with reserves that a bank should hold in excess to its deposit liabilities. Lastly, the discount rates are the interest rates that charged to financial institutions on the loans that they make from The Fed (FRB, 2007)
The US monetary policy not just affects the financial decisions made by people in the United States but also other countries, primarily because it has the largest economy. It affects the people’s decision-making on whether they will put their money in banks, mutual funds, or any other interest earning institution or invest it in business or other capital investment. It is made so that the government has control over the performance of the economy, which are reflected by indicators like inflation, economic output and employment (FRBSF, 2004). According to the Federal Reserve Board, in their Monetary Policy report, the US economy had gone through many economic difficulties over the years.
The US Monetary policy, which includes interest rates, has been changing constantly over the years depending on different situations. During the first half of 2002, after the Sept 11 attack, demand for federal reserves had rise to a large amount. Despite the huge increase, the Federal Reserve was able to manage the increase by reassuring financial markets that the system is functioning well. By doing so, they were able to stabilize transactions in the financial markets. In 2003, US economy is continuously expanding but in a slower pace. Economic expansion, as expected, happened in 2004.
The growth was substantial but inflation was higher than what was expected, the FOMC made sure that it is still in control of the situation and will be held liable of possible outcomes and at the same time, stabilizing the economy (FRB, 2007). The US had experienced enormous changes in its financial sector for the years.
Monetary Policy in 2005 and 2006 was also faced by booms and threats, but was regulated depending on what would be better for the economy. Like for example, According to the July 2006 Report to the Congress, Expansion of the GDP was needed to be controlled for that time because of fortuitous events, that time was the Autumn’s hurricane. It shows that The Fed controls the monetary supply of the nation – whether they will expand or limit money supply depending on what the situation calls for.
- Monetary Policy and Economic Output. Jan 2007.Federal Reserve Board. 29 Apr 2007. <http://www.federalreserve.gov/policy.htm>
- Monetary Policy. Jan 2007. Federal Reserve Bank of San Francisco. 29 Apr 2007. <https://www.frbsf.org/education/teacher-resources/us-monetary-policy-introduction/>