Question

What branch of government does the Federal Reserve System report to? Can this create problems? Briefly describe the three policy tools the Federal Reserve uses to manage the money supply. What are the Federal Reserve’s four monetary policy goals?

Answer 1

The Federal Reserve (Fed) enjoys a unique public / private arrangement that functions within government, but is still largely separate from government to detach the Fed from day-to-day political constraints in performing its varying roles. The Federal Reserve System is regarded as an autonomous central bank. Nevertheless, that is so just in the sense that the President or someone else in the government's executive branch will not have to ratify its decisions. The entire scheme is subject to US scrutiny. The Federal Reserve Congress will function within the scope of the Government's overall economic and financial policy objectives.

The Fed can use four tools to achieve its monetary policy goals: the discount rate, reserve requirements, open market operation

The discount rate is the interest rate on short-term loans that Reserve Banks offer to commercial banks. Federal Reserve discount-rate lending complements open market operations in reaching the federal funds target rate and acts as a source of liquidity for commercial banks to back up. Lowering the discount rate is broad, since certain interest rates are affected by the discount rate. Lower rates promote business and company lending and spending. Similarly, increasing the discount rate is contractionary, since certain interest rates are affected by the discount rate.

Reserve requirements are the portions of reserves that banks are expected to keep in cash, either in their vaults or on a reserve bank account. A reduction in reserve requirements is expansionary as it raises the funds available for lending to customers and companies within the banking system. An rise in reserve requirements is contractionary, as it decreases the funds available for lending to customers and companies in the banking system.

Open market operations, the acquisition and selling of U.S. government securities, is a effective tool. As we heard earlier, this resource is regulated by the FOMC and run by New York's Federal Reserve Bank.

The Federal Reserve Act directs the Federal Reserve to execute monetary policy "to effectively promote the goals of maximum jobs, stable prices and moderate long-term interest rates." While the Act specifies three separate monetary policy goals, the Fed's monetary policy mandate is generally referred to as the dual mandate. The explanation for this is that an economy in which people who want to work either have a job or are likely to find one relatively quickly and in which the price level (meaning a large measure of the price of products and services purchased by consumers) is stable provides the conditions necessary to settle interest rates at moderate levels.