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Monetary Policy Essay

1624 words - 6 pages

Monetary Policy Paper

Introduction

Fiscal and monetary policies focus on quickly returning the economy to sustainable, healthy growth. Any type of fiscal relief package will boost consumer and business spending and can augment the nation's long-term growth potential. Expansionary monetary policy can stimulate growth and provide insurance against the possibility of deflation. This paper will present information on four topics: (1) tools used by the Federal Reserve to control the money supply, (2) how these tools influence the money supply and in turn affect macroeconomic factors? (3) how money is created? (4) recommended monetary policy combinations that best achieve a balance between economic growth, low inflation, and a reasonable rate of unemployment.
Monetary policy is usually administered by a Government appointed "Central Bank", the Bank of Canada and the Federal Reserve Bank in the United States. According to the Encarta the definition of monetary policy is the following economic principles and programs adopted by a government that manage the growth of its money supply, the availability of credit, and interest rates. In the United States, the Federal Reserve Board determines monetary policy.
Fiscal policy is the use of the government budget to affect an economy, Weils points out that when "the government decides on the taxes that it collects, the transfer payments it gives out, or the goods and services that it purchases, it is engaging in fiscal policy" (1). As Weils (2002) further explains, "the primary economic impact of any change in the government budget is felt by particular groups—a tax cut for families with children, for example, raises the disposable income of such families. Discussions of fiscal policy, however, usually focus on the effect of changes in the government budget on the

Monetary Policy Paper 3
overall economy—on such macroeconomic variables as GNP and unemployment and inflation" (1).
Tools used by the Federal Reserve to control money supply?
On The Federal Reserve Web site"The major tool the Fed uses to affect the supply of reserves in the banking system is open market operations—that is, the Fed buys and sells government securities on the open market. These operations are conducted by the Federal Reserve Bank of New York. When the Fed wants the funds rate to rise, it does the reverse, that is, it sells government securities. The Fed receives payment in reserves from banks, which lowers the supply of reserves in the banking system, and the funds rate rises" (http://www.frbsf.org/publications/economics/letter/2004/el2004-01.html#subhead2).
Another tool the Fed uses to affect the supply of reserves The Fed can't control inflation or influence output and employment directly; instead, it affects them indirectly, mainly by raising or lowering a short-term interest rate called the "federal funds" rate. Most often, it does this through open market operations in the market for bank reserves, known as...

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