The Federal Reserve employs various tools to influence financial markets and the economy, including open market operations (buying and selling government securities, which either expands or contracts the money supply in banks), forward guidance, and reactivated programs of “quantitative easing”.
CFR details how the Fed strives for maximum employment and stable prices through policy decisions.
The Federal Open Market Committee (FOMC)
FOMC sets Federal Reserve’s monetary policy goals and targets, such as stable prices and maximum employment. The committee usually meets eight times each year and members are appointed by President for 14-year terms; currently Jerome Powell chairs this body alongside members from Federal Reserve Board as well as presidents of regional Fed banks who sit on it.
The Federal Reserve employs three tools to implement its monetary policy: discount rate, required reserves, and open market operations. By employing these instruments, they influence demand and supply of balances depository institutions lend each other overnight at the Fed, ultimately impacting federal funds rate–the key interest rate which drives all other interest rates within an economy.
The Federal Reserve also publishes projections about future interest rate trends based on its assessment of employment, inflation and growth – these forecasts are keenly monitored by investors; should it achieve its goal of modest inflation with sustained economic expansion it could revert back to historically low interest rates – a so-called “Goldilocks” scenario.
The Federal Reserve System
The Federal Reserve System, more commonly known as “the Fed”, is one of the world’s most influential economic institutions. The Fed sets interest rates and manages money supply while simultaneously regulating banks and monitoring systemic risk. Their decisions are guided by Congress-issued mandates aimed at both maximum employment and price stability.
The Federal Reserve’s monetary policies influence credit availability, and as a result have an enormous influence on everything from housing markets to job markets. Thus, making the Fed a powerful, yet nonpartisan force within our economy.
But the actions of the Federal Reserve are far from uncontroversial. Some economists fear its policies can lead to asset bubbles or inflation; others contend its support of financial markets favors big business over workers. Still, the Fed seems immune from political interference as its Board of Governors and 12 regional Federal Reserve Banks operate independently from Congress appropriations and have long term tenures; therefore a new president cannot expect immediate replacement by new appointments.
Open Market Operations (OMO)
Open market operations (OMOs) are central bank transactions involving buying or selling government securities to modify money supply and indirectly alter interest rates, with this tool serving to fine tune monetary policy.
The Federal Reserve uses OMO to influence the federal funds rate, the interest rate at which depository institutions lend reserve balances overnight to each other. This rate fluctuates based on how much money banks have available for lending.
Expanding monetary policies through lower interest rates encourage consumers and businesses to borrow money to invest or purchase things. Conversely, contractionary policies increase interest rates to discourage borrowing and slow economic growth – ultimately helping control inflation and eliminate unemployment.
Quantitative Easing (QE)
QE (quantitative easing) refers to central bank purchases of assets with the intention of driving down interest rates, typically used during periods of economic distress or crisis. QE3 was completed successfully in March 2020.
As the Federal Reserve purchases longer-term Treasuries from primary dealers in the open market, it increases money availability through bank reserves and reverse repurchase agreements (RRPs). This reduces long-term interest rates and facilitates lower borrowing costs – ultimately spurring economic growth.
QE can have many advantages, yet its risks can also be significant. Raising interest rates on bank reserves can cause financial markets to become unstable; and asset bubbles created through QE could exacerbate income inequality further in America. Still, the Federal Reserve remains committed to using all tools at its disposal to achieve maximum employment and price stability near 2 percent.