Monetary Policy

The U.S. Federal Reserve System The U.S. Federal Reserve System has three main responsibilities To regulate and supervise banks To operate the nations payment systems To establish and implement monetary policy

This lesson focuses on monetary policy: The goals of Monetary Policy are: To maintain economic growth To keep prices stable- trying to avoid inflation or deflation To keep unemployment low

Common Economic Indicators Economic indicators are used to determine if the monetary policy needs adjusting. They may implement tight or loose money policies depending on the situation. These are some of the indicators the Federal Reserve uses: Output- this economic indicator serves as a gauge of the economy’s ability to provide products and services to people

Common Economic Indicators Interest rates- these variables determine consumers’ and businesses’ cost of borrowing credit and therefore affect their spending Trade Balance- This indicator is the difference between the amount of goods and services exported and the amount imported. A strengthening U.S dollar typically causes U.S. imports to rise and exports to fall. A weak dollar causes the opposite.

Common Economic Indicators Inflation- this occurs when there is an increase in the average level of prices of the products and services we buy. ( Monetary policy tries to prevent severe fluctuations) Unemployment- this indicator measures the number of people looking for jobs as a percentage of the total number of people working or looking for work. (Monetary policy tries to keep this number low.

Key Tools of Monetary Policy Discount Rate The interest rate charged by the Federal Reserve to banks that borrow on a short- term (usually overnight) basis Reserve Requirements The amount of money banks must keep on reserve at the Fed Open Market Operations Buying and selling Treasury securities between the Fed and selected financial institutions in the open market Most important tool

Tight Monetary Policy- restrains inflation Feds take money out the economy by selling securities This creates a rise in the federal funds rate Banks then have less money to spend

Tight Monetary Policy- restrains inflation Consumers and businesses may borrow less Consumers and businesses spending may decrease Inflation goes down. Unemployment goes up

LOOSE OR EASY MONETARY POLICY- fights recession The Fed buys securities which add money to the economy. This decreases the federal funds rate Short-term interest rates go down

LOOSE OR EASY MONETARY POLICY- fights recession Consumers and businesses may borrow more money Consumers and businesses’ spending may increase Inflation may go up Unemployment may go down

Impact on international trade When the Federal Reserve adjusts interest rate it also impacts international trade: A higher interest rates result in a stronger currency, benefitting importers. A lower interest rate results in a weaker currency, benefitting exporters.