Extra Credit (Fall 2006)


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Monetary Policy
Q: How does the Federal Reserve implement monetary policy?
A:

The Federal Reserve implements monetary policy using three major tools:

  • open market operations—the buying and selling of U.S. Treasury and federal agency securities on the open market;
  • discount window lending—lending to depository institutions directly from their Federal Reserve Bank’s lending facility (the discount window), at rates set by the Reserve Banks and approved by the Board of Governors;
  • reserve requirements—requirements regarding the amount of funds that depository institutions must hold in reserve against deposits made by their customers.
Using these tools, particularly open market operations, the Fed influences the demand for and supply of balances that depository institutions hold on deposit at Federal Reserve Banks (the key component of reserves) and thus the federal funds rate—the interest depository institutions charge each other on overnight sales of required balances at the Federal Reserve. Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, and the amount of money and credit in the economy. These changes, ultimately, affect a range of economic variables, including employment, output, and the prices of goods and services.
Q: What is the Federal Open Market Committee, and what does it do?
A:

The Federal Open Market Committee (FOMC) is the monetary policymaking body of the Federal Reserve System, responsible for formulating monetary policy for the United States. The goals of monetary policy, as spelled out in the Federal Reserve Act, are “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

The FOMC sets monetary policy by specifying the short-term objective for open market operations—purchases and sales of U.S. government and federal agency securities. Open market operations, the principal tool of monetary policy, affect the availability of reserves to depository institutions and, in turn, the cost and availability of money and credit in the U.S. economy. The FOMC sets a target level for the federal funds rate (the rate that depository institutions charge on overnight sales of immediately available funds among themselves).

The FOMC also directs Federal Reserve operations related to trading foreign currencies; these operations are coordinated with the U.S. Treasury, which is responsible for formulating U.S. policies regarding the exchange value of the dollar.
Q: Who are the members of the Federal Open Market Committee?
A:

The Federal Open Market Committee (FOMC) consists of 12 voting members: the seven members of the Board of Governors and five of the 12 Federal Reserve Bank presidents. The president of the Federal Reserve Bank of New York serves on a permanent basis; the presidents of the other Reserve Banks serve one-year terms on a rotating basis beginning on Jan. 1 of each year. The rotating seats are filled from the following four groups of banks, one president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco.

Current members of the FOMC