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. When was the last time the Federal Reserve hiked interest rates?

    Learn about when the U.S. Federal Reserve last increased the federal funds target rate, which was in June 2006 after the ... Read Answer >>
  2. Who determines interest rates?

    In countries using a centralized banking model, interest rates are determined by the central bank. In the first step of interest ... Read Answer >>
  3. What are the implications of a low Federal Funds Rate?

    Find out what a low federal funds rate means for the economy. Discover the effects of monetary policy and how it can impact ... Read Answer >>
  4. 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 >>
  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

    Understanding the Federal Open Market Committee

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

    How Federal Open Market Committee Meetings Drive Rates And Stocks

    Janet Yellen's first Federal Open Market Committee (FOMC) meeting - and its aftermath - is an important bellwether for the immediate future of the U.S. economy.
  3. Investing

    How The U.S. Government Formulates Monetary Policy

    Learn about the tools the Fed uses to influence interest rates and general economic conditions.
  4. Insights

    A Fed Divided: The Unknowns Blocking FOMC Consensus

    We examine what the latest FOMC meeting minutes are telling us about the conversations behind the door of the Eccles Building.
  5. Financial Advisor

    What to Expect at April's FOMC Meeting

    The Fed won't raise rates Wednesday, but it's worth paying close attention to Yellen's comments about the future trajectory of rates.
  6. Investing

    What's Tight Monetary Policy?

    A tight monetary policy constricts spending and curbs inflation.
RELATED TERMS
  1. Federal Open Market Committee Meeting - FOMC Meeting

    The meeting of the Federal Open Market Committee (FOMC) that ...
  2. Target Rate

    The interest rate charged by one depository institution on an ...
  3. Monetary Policy

    Monetary policy is the actions of a central bank, currency board ...
  4. Easy Money

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

    The federal funds rate is the interest rate at which a depository ...
  6. Federal Discount Rate

    The interest rate set by the Federal Reserve that is offered ...
Hot Definitions
  1. Short Covering

    Short covering is buying back borrowed securities in order to close an open short position.
  2. Covariance

    A measure of the degree to which returns on two risky assets move in tandem. A positive covariance means that asset returns ...
  3. Liquid Asset

    An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally ...
  4. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
  5. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  6. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
Trading Center