Monetary Policy of the Federal Reserve
The Federal Reserve System, established in 1913, is the United States’ central bank. This system consists of twelve district banks and a Board of Governors. The Federal Reserve is independent within the government, which means, “even though the Fed is independent of Congressional appropriations and administrative control, it is ultimately accountable to Congress and comes under government audit and review” (frbsf.org). The Federal Open Market Committee (FOMC) conducts the monetary policy. This committee meets eight times per year and consists of 12 members (the President of the Federal Reserve Bank of New York, the seven members of the Board of Governors, and four district Reserve Bank Presidents who serve in rotation). The current Chairman of the FOMC is Ben S. Bernanke. The purpose of the Monetary Policy is to influence the economy in relation to inflation, output, and employment. The Monetary Policy influences indirectly by raising and lowering short-term interest rates, which are also known as “federal funds” rates. The purpose of the raising and lowering of interest rates is to affect people and firms’ demand for goods and services. “Monetary Policy has two basic goals: to promote ‘maximum’ sustainable output and employment and to promote ‘stable’ prices. These goals are prescribed in a 1977 amendment to the Federal Reserve Act (frbsf.org). When the real interest rates are lower, there is an increase in investment spending which leads to the purchase of more durable goods. Lower rates also increase a financial institution’s likeliness to lend to households and firms.
“The Fed uses three monetary policy tools to influence the availability and cost of money and credit: open market operations, the discount rate, and reserve requirements (frbsf.org). The open market operations for buying or selling of government securities is the most often-used monetary tool. The Federal Reserve pays for government securities by crediting the reserve accounts of banks involved in the sale. The second monetary tool, the discount rate (set by the board of directors) is the interest rate a financial institution is charged for borrowing funds on a short-term basis. The final monetary tool is reserve requirements. By law, financial institutions are required to designate a portion of their deposits as reserves. Not only are reserves used to satisfy the reserve requirement, but they are also used to process financial transactions through the Reserve Bank.
The Federal Open Market Committee provides a summary of the current economic conditions, which is known as the Beige Book. The Beige Book is published eight times per year, and contains information on the current economic conditions of each district through reports from the bank directors. The most recent summary was published on June 10, 2009. From this report, the overall economic condition of the twelve district banks remained weak. Five districts did note however that the downward trend is moderately slowing down. According to the Beige Book, “Manufacturing activity declined or remained at a low level across