Monetary Policy
The Economy of any nation is very dynamic and various issues such as inflation, rate of economic growth, the movement of the currency’s exchange rate among others are constantly monitored to keep them within appropriate ranges. This is the task of the central monetary authority which in the USA is called the Federal Reserve.
The Federal Reserve (the Fed) does this by using one or more of the following: controlling the supply of money in the economy, controlling the availability of money and controlling the cost of money or the interest rate. These three form the main options that make up what is called the Monetary Policy.
The Monetary Policy can take on two forms; it can be an expansionary policy, or a contractionary policy. When economic growth reaches a very high level, there is a lot of money in the economy and this usually leads to higher rates of inflation as people are willing to pay more for the same products. In this case the Fed increases interest rates which entices people to invest their money while making it costlier for them to borrow money for consumption. The interest rate the Fed charges banks for borrowing is higher. This filters down to increased interest rates for business and personal borrowing. With loans becoming costlier then less is borrowed and this cools down the economic growth. All these steps form the contractionary policy.
On the other hand in a state of recession or economic slowdown people consume less affecting industries negatively and unemployment levels start to rise. Here the Federal Reserve provides a boost by reducing interest rates. This not only makes it easier for consumers to get cheap loans and consume more, it also makes the funds required by industry used for growth available at less cost. Banks are also allowed to reduce the amount they have to maintain with the Fed and give out more of their funds as loans. All these steps constitute an expansionary policy. This is what the Federal Reserve is doing right now; interest rates have been slashed to make it easier for consumers as well as industry to borrow at inexpensive rates. Banks are being encouraged to lend more so that consumption increases and businesses benefit. Money required by businesses to expand and continue their operations has been made easier. Business activity picks up and employment goes up. All these steps are being used to bring the economy out of the lows that it presently is in. The Fed in this way controls the whole economy with its Monetary Policy; each step taken by it has to be well thought out to ensure that economic growth stays at an appropriately high level while ensuring inflation is kept under control.
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The Federal Reserve (the Fed) does this by using one or more of the following: controlling the supply of money in the economy, controlling the availability of money and controlling the cost of money or the interest rate. These three form the main options that make up what is called the Monetary Policy.
The Monetary Policy can take on two forms; it can be an expansionary policy, or a contractionary policy. When economic growth reaches a very high level, there is a lot of money in the economy and this usually leads to higher rates of inflation as people are willing to pay more for the same products. In this case the Fed increases interest rates which entices people to invest their money while making it costlier for them to borrow money for consumption. The interest rate the Fed charges banks for borrowing is higher. This filters down to increased interest rates for business and personal borrowing. With loans becoming costlier then less is borrowed and this cools down the economic growth. All these steps form the contractionary policy.
On the other hand in a state of recession or economic slowdown people consume less affecting industries negatively and unemployment levels start to rise. Here the Federal Reserve provides a boost by reducing interest rates. This not only makes it easier for consumers to get cheap loans and consume more, it also makes the funds required by industry used for growth available at less cost. Banks are also allowed to reduce the amount they have to maintain with the Fed and give out more of their funds as loans. All these steps constitute an expansionary policy. This is what the Federal Reserve is doing right now; interest rates have been slashed to make it easier for consumers as well as industry to borrow at inexpensive rates. Banks are being encouraged to lend more so that consumption increases and businesses benefit. Money required by businesses to expand and continue their operations has been made easier. Business activity picks up and employment goes up. All these steps are being used to bring the economy out of the lows that it presently is in. The Fed in this way controls the whole economy with its Monetary Policy; each step taken by it has to be well thought out to ensure that economic growth stays at an appropriately high level while ensuring inflation is kept under control.
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