Fed Reserve Monetary Policy

Fed Reserve Monetary Policy

Subject :Economy

Section: External Sector

Context: The Federal Reserve raised interest rates by the steepest increment since 2000 and decided to start shrinking its massive balance sheet, deploying the most aggressive tightening of monetary policy in decades to control soaring inflation.

Decisions taken:

• Increase Benchmark rate– The increase in the Federal Open Market Committee’s target for the federal funds rate, to a range of 0.75% to 1%, follows a quarter-point hike in March that ended two years of near-zero rates to help cushion the U.S. economy against the initial blow from Covid-19.

• Reduce Balance sheet– by selling the Treasuries and mortgage-backed securities. The balance sheet had ballooned in size as the Fed aggressively bought securities to calm panic in financial markets and keep borrowing costs low as the pandemic spread.

Impact:

These twin measures will reduce the quantity of surplus liquidity in the system as well as increase the cost of funds.

Fed Reserve and the Monetary Policy:

The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy.

The Federal Reserve controls the three tools of monetary policy–open market operations, the discount rate, and reserve requirements.

• The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and
• The Federal Open Market Committee is responsible for open market operations.

Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.

Impact/Policy implications:

Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services.

Structure of the FOMC

The Federal Open Market Committee (FOMC) consists of twelve members–

• The seven members of the Board of Governors of the Federal Reserve System;
• The president of the Federal Reserve Bank of New York; and
• The four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis.

Nonvoting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee’s assessment of the economy and policy options.

The FOMC holds eight regularly scheduled meetings per year. At these meetings, the Committee reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.

Goals:

The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates.