What is monetary policy?

What is monetary policy?

We discussed the necessity for an economy to experience growth in cycles to maintain stability. This is because we aim to prevent rapid economic expansions that could lead to future crashes. When the economy grows too swiftly, an eventual crash becomes unavoidable.

In many countries, including the United States, there is a specific inflation rate targeted for economic growth. For instance, the U.S. aims for an inflation rate of 2% annually. The government makes efforts to maintain this 2% inflation rate consistently, as it is considered a healthy level of inflation for the economy.

With that in mind, the government possesses two distinct approaches to influence the growth or slowdown of the economy: monetary policy and fiscal policy.

What is monetary policy?

Monetary policy involves managing the money supply and determining interest rates.

When the money supply increases, the economy tends to grow faster due to higher spending. Conversely, a reduced money supply leads to a slower economy. Similarly, lower interest rates strengthen the economy, promoting borrowing and investment, while higher interest rates tend to slow down economic activity.

What are Central banks?

Governments implement their monetary policy through their central banks. A central bank is an institution responsible for overseeing a country’s currency, money supply, and interest rates. Its primary role is to regulate the monetary system with the aim of mitigating economic crises and ensuring stability within the economy.

Typically, every country has its own central bank, functioning as an integral part of the nation’s financial system. However, in the United States, we have the Federal Reserve, commonly known as the FED. The Federal Reserve was established in 1910 and officially enacted into law with “The Federal Reserve Act” in 1913. It plays a crucial role in overseeing the country’s monetary policies and financial stability.

The Federal Reserve (FED) is composed of various entities that collectively oversee and manage the central banking system in the United States. These entities include:

Board of governors of federal reserve system

The Board of Governors is the primary governing body of the Federal Reserve System. It consists of seven members who are appointed by the President of the United States and confirmed by the Senate. Each member serves a 14-year term to ensure their independence from political pressures. The Chair of the Board is also appointed by the President and serves a four-year term. The Board of Governors is responsible for setting monetary policy, including decisions related to interest rates and the money supply.

What are federal reserve banks?

There are twelve regional Federal Reserve Banks spread across the United States. Each Federal Reserve Bank operates within its designated district and serves as a decentralized arm of the central banking system. These banks play a crucial role in implementing monetary policy, supervising and regulating financial institutions, and providing various banking services to depository institutions within their districts.

What is federal open market committee (FOMC)?

The FOMC is a key component of the Federal Reserve System and is responsible for formulating the country’s monetary policy. It consists of the seven members of the Board of Governors and five Reserve Bank Presidents. The Chair of the Board of Governors serves as the Chair of the FOMC. The FOMC meets regularly to discuss economic conditions and make decisions about interest rates and other monetary policy measures.

Their responsibility includes engaging in transactions involving government securities. When they sell these securities, it results in a decrease in the money supply within the market. This happens because when people purchase these securities, it leads to a reduction in the amount of money circulating in the economy. On the other hand, when they buy back these securities from the public, they inject money into the market, thereby increasing the money supply.

Who are member banks?

National banks and state-chartered banks that meet certain criteria are required to become members of the Federal Reserve System. Member banks hold stock in their regional Federal Reserve Bank and elect six of the nine members of each Reserve Bank’s board of directors.


Overall, the Federal Reserve operates as an independent entity within the government, aiming to foster a stable financial system and promote economic growth while keeping inflation in check. Its structure allows for a combination of centralized decision-making by the Board of Governors and decentralized operations through the regional Federal Reserve Banks.

Central banks worldwide undertake similar actions to achieve a common goal: ensuring financial stability. They are endowed with the authority and capability to implement measures aimed at fostering a stable and robust financial system.

Typically, their website offer information about their activities and the direction they are taking.