Monetary Policy Ulrica Clark Chapter 15 Monetary Policy Monetary policy has some basic goals: to promote 'maximum's ustainable output and employment and to promote 'stable' prices. 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 Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy. The Fed can not control inflation or influence output and employment directly; instead, it affects them indirectly, mainly by raising or lowering a short-term interest rate called the 'federal funds' rate. The Federal Reserve has certain tools at its disposal to control monetary policy, open market operations, the discount rate, and reserve requirements.
The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. Using these tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. The point of implementing policy through raising or lowering interest rates is to affect people's and firms' demand for goods and services.
Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables. This shows how policy actions affect real interest rates, which in turn affect demand and ultimately output, employment, and inflation. Monetary policy can be quickly altered and can affect money supply and investments very fast thus making speed and flexibility one of its strength. Members of the Feds board are appointed a 14 year term. This isolates them from lobbying so therefore no political pressure to contend with. The tight monetary policy helped the economy succeed from 1980 thru to 1990 by bringing down the inflation rate.
Monetary policy is not all strengths there are weaknesses also associated with this policy. One weakness is the growth of electronic transactions. These transactions have made it easier for people to move money to and from accounts within the financial industries, therefore giving the Feds less control of the money supply. Another weakness is changes in velocity which will frustrate the monetary policy. This works against the Feds in time of inflation and recession. Monetary policy is less reliable in pushing the economy out of recession causing the economy to suffer from cyclical asymmetry..