Question

Discuss how effective the federal open market committee has been using open market operations to achieve its goals of price stability and maximum employment

Answer 1

Open market operations are one of the ways of enacting monetary policies by the federal reserve. The federal reserve is in charge of the three tools of monetary policy namely -

• Open market operations
• Discount rate
• Reserve requirements

The fed using varying policies control the inflation, amount of money in the economy, the interest rates and hence the performance of the economy.

The FOMC or the federal open market committee is a twelve member body which holds regular scheduled meetings each year to decide upon these policies. Open market operations take place by the fed buying or selling government securities. When the fed is looking for expansionary monetary policies it buys the government bonds from various banks, hence increasing the money available with the banks which they can lend out further. The opposite is the case when the fed is looking for a contractionary policy i.e. it sells the bonds.

Now when the banks have ample capital to lend out, the supply increases while the demand remains the same. This, in turn, decreases interest rates(assuming other factors to be constant). People have a great deal of money in their hand. People now spend more and save less(since interest rates are low). Firms, in turn, produce more, hire more and hence unemployment goes down and the overall economy gets fueled.

If there is a difference between the supply and demand of money, the fed decides to supply or cut down on the money in the economy which in turn controls the price stability. When the demand and supply for money becomes equal, there exists an equilibrium and in turn,prices become stable.