Macroeconomics : The Fed

If you haven't taken macro economics in the last 20 years, this is worth a look or a refresher.

It is very interesting to compare the effectiveness of monetary (FOMC aka. 'the Fed') versus fiscal (legislative government) policy.

According to Keynesian theory of the 1960's, the economy can best be controlled through monetary policy. Therefore, the legislative branch defers to the Federal Reserve (a non-political organization that is not a part of the Federal government) to prevent inflation.

Ideally, we prefer a growing GDP, no unemployment, and zero inflation. Since it is impossible to fine tune the nation's complex economy to hit a target of zero inflation without the risk of encountering deflation (negative inflation), the Fed targets a healthy 1-2% inflation rate.


Although the Fed has three monetary policy tools, only the Open Market Operations is the most powerful tool that can be used to make daily adjustments in controlling the money supply. Sales of T-bills is contractionary because it attracts the excess money reserves.
In a quarterly fashion, the Fed could change the Discount Rate (interest rate the Fed will charge banks for loans) which influences other rates and indexes (Fed Funds Rate, Prime rate, etc.). A lower rate signals a recession and is expansionary monetary policy.
In the long run, it is also possible to change the Reserve Requirements of banks (the amount of deposits they must keep on hand) which affects the money supply through the Money Multiplier. Higher bank reserves are contractionary to the money supply; lower reserves allow more lending, more spending, and create money supply.

Policymaking
- Federal Open Market Committee
Policy tools
- Open market operations
- The discount rate
- Reserve requirements
http://www.federalreserve.gov/policy.htm