A:

Regulating the money supply is the sole tool of the Federal Reserve's monetary policy. The Federal Reserve can affect the money supply through its monetary policy in three ways: with open market operations, through the required reserve ratio and through the discount rate.

Open market operations affect the money supply through buying and selling U.S. government securities. The Federal Reserve can increase the money supply by buying securities and decrease the money supply by selling securities.

The required reserve ratio affects the money supply by regulating how much money banks must hold in reserve. If the Federal Reserve wants to increase the money supply, it can decrease the amount of reserves required, and if it wants to decrease the money supply, it can increase the amount of reserves required to be held by banks.

The third way the Federal Reserve's monetary policy regulates the money supply is through the discount rate, which is the rate at which banks can borrow money from the Federal Reserve. If the Federal Reserve wants to increase the money supply, it can decrease the discount rate and encourage banks to borrow more money for lending. If it wants to decrease the money supply, it can increase the discount rate and discourage banks from borrowing money.

All of this works to do a few very specific things. Increasing the money supply through monetary policy can decrease interest rates; increase savings and investments; and increase consumer spending, therefore expanding the economy. Decreasing the money supply has the opposite effects.

RELATED FAQS
  1. Why would the Federal Reserve change the reserve ratio?

    Understand the Federal Reserve's monetary policy and the tools it uses to change that monetary policy. Learn about the reserve ... Read Answer >>
  2. How do central banks inject money into the economy?

    Central banks use several different methods to increase (or decrease) the amount of money in the banking system. These actions ... Read Answer >>
  3. How does the law of supply and demand affect monetary policy in the United States?

    Learn about how the law of supply and demand affects monetary policy in the United States. Changing interest rates leads ... Read Answer >>
  4. Who determines the reserve ratio?

    Understand what the Federal Reserve is and what it regulates in the U.S. economy. Learn about the reserve ratio and how the ... Read Answer >>
  5. What precise measures are implemented in most monetary policies?

    Read about some of the precise measures implemented in most monetary policies, and learn why monetary policy is considered ... Read Answer >>
Related Articles
  1. Trading

    How Does Money Supply Affect Interest Rates?

    A larger money supply lowers market interest rates, while a smaller supply tends to raise them.
  2. Insights

    How The Federal Reserve Manages Money Supply

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

    How Much Influence Does The Fed Have?

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

    Explaining the Federal Reserve System

    The Federal Reserve System is the central bank of the United States. It regulates monetary policy and supervises the nation’s banking system.
  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. Personal Finance

    How the Federal Reserve Affects Your Mortgage

    The Federal Reserve can impact the cost of funds for banks and consequently for mortgage borrowers when maintaining economic stability.
  7. Investing

    Understanding Money Supply

    Money supply – also called money stock -- refers to the total amount of currency and other liquid financial products in an economy at a particular time.
  8. Insights

    Government Policies to Control Inflation

    Inflation occurs when an economy grows due to increased spending.
  9. Investing

    What's Tight Monetary Policy?

    A tight monetary policy constricts spending and curbs inflation.
RELATED TERMS
  1. Federal Discount Rate

    The interest rate set by the Federal Reserve that is offered ...
  2. Monetary Policy

    Monetary policy is the actions of a central bank, currency board ...
  3. Reserve Ratio

    The portion (expressed as a percent) of depositors' balances ...
  4. Adjustment Credit

    A short-term loan made by a Federal Reserve Bank to a smaller ...
  5. Reserve Requirements

    Requirements regarding the amount of funds that banks must hold ...
  6. Accommodative Monetary Policy

    When a central bank (such as the Federal Reserve) attempts to ...
Hot Definitions
  1. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  2. Whole Life Insurance Policy

    A life insurance contract with level premiums that has both an insurance and an investment component. The insurance component ...
  3. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  4. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. ...
  5. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability of potential investments.
  6. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
Trading Center