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.

  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. 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 >>
  5. What is the structure of the U.S. Federal Reserve Bank?

    Wonder how the U.S. Federal Bank began and how it works today? Learn how this complex system is structured and how it works ... Read Answer >>
Related Articles
  1. Insights

    How Much Influence Does The Fed Have?

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

    What are the Federal Reserve Chairman's responsibilities?

    Learn about the duties and responsibilities of the chairman of the Federal Reserve Board, including testifying before Congress and as acting as chair of the FOMC.
  3. Insights

    Top 4 Central Banks Dominating the World Economy

    Central banks play an integral role in market economies by maintaining the stability and credibility of national currencies used in those economies.
  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. Insights

    Fiscal Policy vs. Monetary Policy: Pros & Cons

    When it comes to influencing macroeconomic outcomes, governments have typically relied on one of two courses of action: monetary policy or fiscal policy.
  6. 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.
  7. Insights

    Understanding How the Federal Reserve Creates Money

    Read about how the Federal Reserve actually targets and creates new money in the economy, and find out why the savings and loans system magnifies this process.
  1. Federal Open Market Committee (FOMC)

    The Federal Open Market Committee (FOMC) is the branch of the ...
  2. Target Rate

    Target rate is the interest rate charged by one depository institution ...
  3. Open Market Operations - OMO

    Open market operations refer to the buying and selling of government ...
  4. Accommodative Monetary Policy

    Accommodative monetary policy occurs when a central bank attempts ...
  5. Federal Reserve System - FRS

    The Federal Reserve System, commonly known as the Fed, is the ...
  6. Monetary Base

    A monetary base is the total amount of a currency in general ...
Hot Definitions
  1. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  2. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  3. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  4. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  5. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  6. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
Trading Center