A:

Formulating a country's monetary policy is extremely important when it comes to promoting sustainable economic growth. More specifically, monetary policy focuses on how a country determines the size and rate of growth of its money supply in order to control inflation within the country.

In the United States, a committee within the Federal Reserve is responsible for implementing monetary policy. The Federal Open Market Committee (FOMC) is comprised of the Board of Governors and five reserve-bank presidents, and it meets eight times throughout the year to set key interest rates and to determine whether to increase or decrease the money supply within the economy.

The FOMC buys and sells government securities to set the money supply. The is process is called open market operations. The government securities that are used in open market operations are Treasury bills, bonds and notes. If the FOMC wants to increase the money supply in the economy it will buy securities. Conversely, if the FOMC wants to decrease the money supply, it will sell securities.

To increase the money supply in the market, the FOMC will purchase securities from banks. The funds that the banks acquire from the sale can be used as loans to individuals and businesses. The more money that is available in the market for lending, the lower the rates on these loans become, which causes more borrowers to access cheaper capital. This easier access to capital leads to greater investment and will often stimulate the overall economy.

To decrease the money supply, the FOMC will sell securities to banks, which leads to money being taken out of the banks and kept in FOMC reserves. The decrease in money available in the economy leads to a decrease in investment and spending as the availability of capital decreases and it becomes more expensive to obtain. This limiting of access to capital slows down economic growth as investment decreases.

To learn more, see Formulating Monetary Policy, The Federal Reserve and Get To Know The Major Central Banks.

RELATED FAQS
  1. How do open market operations affect the money supply of an economy?

    Understand how open market operation affect the supply of money in the economy and learn the specific ways the Federal Reserve ... Read Answer >>
  2. How do open market operations affect the overall economy?

    Understand how open market operations affect the overall economy. Learn how the Federal Reserve uses open market operation ... Read Answer >>
  3. What are some different kinds of expansionary policy?

    Learn the most popular types of expansionary policy used by the federal government and the Federal Reserve to increase the ... Read Answer >>
  4. How does monetary policy influence inflation?

    Take a deeper look at how contemporary central banks attempt to target and control the level of inflation through monetary ... Read Answer >>
  5. What happens if the Federal Reserve lowers the reserve ratio?

    Learn about the Federal Reserve's monetary policy and the tools it uses to control it. Understand what happens if the Federal ... Read Answer >>
  6. What are some examples of expansionary monetary policy?

    Learn about expansionary monetary policy and how central banks use discount rates, reserve ratios and purchases of securities ... Read Answer >>
Related Articles
  1. Trading

    Understanding the Federal Open Market Committee

    The Federal Open Market Committee is the branch of the Federal Reserve Board that determines monetary policy.
  2. Trading

    Monetary Policy

    Monetary policy is a central bank’s actions that influence the country’s money supply and the overall economy.
  3. Insights

    How Much Influence Does The Fed Have?

    Find out how current financial policies may affect your portfolio's future returns.
  4. Insights

    Fiscal Vs. Monetary Policy Pros & Cons

    When it comes to influencing macroeconomic outcomes, governments have typically relied on one of two primary courses of action: monetary policy and fiscal policy.
  5. Trading

    Open Market Operations Explained

    The term “open market operations” refers to a monetary policy tool in which central banks buy and sell bonds to regulate the money supply in the economy. The United States employs open market ...
  6. Insights

    How The Federal Reserve Manages Money Supply

    Find out how the Fed manages bank reserves and this contributes to a stable economy.
  7. Insights

    How Does China Manage Its Money Supply?

    Here's how the Central Bank of China manages its currency rates and the money supply.
RELATED TERMS
  1. Monetary Policy

    Monetary policy is the actions of a central bank, currency board ...
  2. Federal Open Market Committee - FOMC

    The branch of the Federal Reserve Board that determines the direction ...
  3. Money Supply

    The entire stock of currency and other liquid instruments in ...
  4. Easy Money

    In the most literal sense, money that is easily acquired. Academically ...
  5. Target Rate

    The interest rate charged by one depository institution on an ...
  6. Monetary Theory

    A set of ideas about how monetary policy should be conducted ...
Hot Definitions
  1. Derivative

    A security with a price that is dependent upon or derived from one or more underlying assets.
  2. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  3. Sharpe Ratio

    The Sharpe Ratio is a measure for calculating risk-adjusted return, and this ratio has become the industry standard for such ...
  4. Death Taxes

    Taxes imposed by the federal and/or state government on someone's estate upon their death. These taxes are levied on the ...
  5. Retained Earnings

    Retained earnings is the percentage of net earnings not paid out as dividends, but retained by the company to be reinvested ...
  6. Demand Elasticity

    In economics, the demand elasticity refers to how sensitive the demand for a good is to changes in other economic variables. ...
Trading Center