Monetary Policy of the FED

Tanya Shah

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The Logo of The Federal Reserve System of the United States

What is Monetary Policy?

The monetary policy is what the Fed, which is the nation's central bank, does in order to impact the amount of money and credit in the U.S. economy. They control the supply of money. The interest rates, or cost of credit, and the performance of the U.S. economy are affected by what they do to the money and credit.
The picture here shows two of the members trying to form monetary policy.

The Goals of Monetary Policy

The monetary policy aims to promote:
  • a low unemployment rate
  • durable prices
  • steady interest rates
If the monetary policy is successful in maintaining stable prices, it can create a base for long-term economic growth and maximum employment.
The picture here shows how monetary policy promotes a healthy economy.


Inflation is when the price of goods and services increases by a lot. It is a bad thing because it causes the value of the currency to decline, and also slows down economic growth. Inflation can happen if the supply of money and credit increases really rapidly.
The picture here shows how inflation causes the prices of items to rise, which causes the cost of the currency to rise too.
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This picture shows how inflation influences the economy. As inflation grows, the economy shrinks. Little inflation keeps the economy better.

The Tools of Monetary Policy:

Open Market Operations

Open market operations is the most highly used tool of the Fed. Those operations are carried out by the Domestic Trading Desk of the Federal Reserve Bank of New York, who are told to do so by the FOMC.
When the Fed wants to:
  • increase reserves: it buys securities and then makes a deposit in the primary dealer's account that is maintained at the Fed, and that's how they pay for the securities.
  • decrease reserves: it sells securities and that way gets from those accounts.
  • neither increase not decrease reserves: it enrolls in transactions that last for only a couple days
The trading of securities like this affects the amount of bank reserves, which in turn affects the federal funds rate, which is the rate at which banks borrow reserves from each other.


The FOMC are the creators of the monetary policy. The members of the FOMC include:
  1. Board of Governors; BOG (7 people)
  2. President of the Federal Reserve Bank of NY & presidents of four other Reserve Banks (rotate every year)
The FOMC call a meeting around eight times a year at Washington D.C. At the meeting, they discuss and talk about the U.S. economy and monetary policy.
This is a picture of the members of the FOMC in 2012.

A FOMC Meeting

This is basically what happens at the meeting:
First, a senior official from the NY Federal Reserve Bank talks about how the financial and foreign markets have developed, and the details of the changes since the past FOMC meeting. Then, in turns, the other officials and presidents present their perspectives on the economic outlook, as well as their economic and financial forecasts. In the end, the members discuss their alternatives about the policy, and finally vote.
To apply the policy action, the Committee sends a directive to the NY Fed's Domestic Trading Desk that shows the implementation of the Committee's policy through open market operations.
The Fed conducts open market operations several times a week because they want to prevent technical forces from pushing the federal funds rate further away from the target rate.
This is a picture of one of the FOMC meetings in 2012.