Print
What is monetary policy?
The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit as a means of helping to promote national economic goals.
The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit as a means of helping to promote national economic goals.
For more information, see U.S. Monetary Policy: An
Introduction, on the Federal Reserve Bank of San
Francisco's web site.
How does the Federal Reserve implement monetary policy?
The Federal Reserve implements monetary policy using three major tools:
The Federal Reserve implements monetary policy using three major tools:
- Open market operations. The
buying
and selling of U.S. Treasury and federal agency securities
in the open market
- Discount window lending.
Lending to depository institutions directly from their
Federal Reserve Bank's lending facility (the discount
window), at rates set by the Reserve Banks and approved
by
the Board of Governors
- Reserve requirements. Requirements regarding the amount of funds that depository institutions must hold in reserve against deposits made by their customers.
Using these tools, the
Federal
Reserve influences the demand for and supply of balances
that depository institutions hold on deposit at Federal
Reserve Banks (the key component of reserves) and thus the
federal funds rate--the interest rate charged by one
depository institution on an overnight sale of balances at
the Federal Reserve to another depository institution.
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 in the economy, and, ultimately, a range
of economic variables, including employment, output, and
the prices of goods and services.
What is the federal funds rate, and why does the FOMC raise or lower the target rate?
The federal funds rate is the rate charged by one depository institution on an overnight sale of immediately available funds (balances at the Federal Reserve) to another depository institution; the rate may vary from depository institution to depository institution and from day to day. The target federal funds rate is set by the Federal Open Market Committee (FOMC). By setting a target federal funds rate and using the tools of monetary policy-- open market operations, discount window lending, and reserve requirements--to achieve that target rate, the Federal Reserve and the FOMC seek "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates," as required by the Federal Reserve Act.
The federal funds rate is the rate charged by one depository institution on an overnight sale of immediately available funds (balances at the Federal Reserve) to another depository institution; the rate may vary from depository institution to depository institution and from day to day. The target federal funds rate is set by the Federal Open Market Committee (FOMC). By setting a target federal funds rate and using the tools of monetary policy-- open market operations, discount window lending, and reserve requirements--to achieve that target rate, the Federal Reserve and the FOMC seek "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates," as required by the Federal Reserve Act.
At each of its meeting, the FOMC examines a number of indicators of current and prospective economic developments. Then, cognizant that its actions affect economic activity with a lag, it must decide whether to alter its target for the federal funds rate. An actual decline in the rate stimulates economic growth, but an excessively high level of economic activity can cause inflation pressures to build to a point that ultimately undermines the sustainability of an economic expansion. An actual rise in the rate curbs economic growth and helps contain inflation pressures, and thus can promote the sustainability of an economic expansion; too great a rise, however, can retard economic growth too much. The FOMC's actions on the target federal funds rate are undertaken to achieve the maximum rate of economic growth consistent with price stability and moderate long- term interest rates.
For more information on the federal funds rate, see The Federal Reserve System: Purposes and Functions on the Board of Governors' web site.
What are the historical changes in the target federal funds rate?
The Federal Reserve's objective in using the tools of monetary policy may be a desired quantity of reserves or a desired price of reserves--the federal funds rate. During the 1980s, the approach gradually changed from seeking a desired quantity of reserves toward attaining a specified level of the federal funds rate, a process that was largely complete by the end of the decade. In 1995, the FOMC began announcing its target level for the federal funds rate. Historical changes in the target federal funds rate are available on the Board of Governors' web site.
The Federal Reserve's objective in using the tools of monetary policy may be a desired quantity of reserves or a desired price of reserves--the federal funds rate. During the 1980s, the approach gradually changed from seeking a desired quantity of reserves toward attaining a specified level of the federal funds rate, a process that was largely complete by the end of the decade. In 1995, the FOMC began announcing its target level for the federal funds rate. Historical changes in the target federal funds rate are available on the Board of Governors' web site.
What is the money stock, and how does the Federal Reserve influence it?
Generally, the money stock consists of currency held by the public; transaction, savings, and time deposits held by the public at depository institutions; the assets of money market mutual funds; and certain other depository institution liabilities. The Federal Reserve affects the money stock chiefly by its influence over interest rates. When the Federal Open Market Committee lowers the target federal funds rate, the rate at which depository institutions purchase and sell overnight funds to one another in the market falls, and so do other short-term interest rates. Lower short-term market interest rates increase the attractiveness of the rates paid on deposits at commercial banks and other depository institutions because changes in these rates tend to lag changes in market rates. Consequently, the public tends to purchase the assets included in the money stock, and money growth increases. Conversely, when the FOMC raises the target federal funds rate, the federal funds rate increases, as do other short-term interest rates. The rates paid on assets included in the money stock become less attractive, and money growth slows.
Generally, the money stock consists of currency held by the public; transaction, savings, and time deposits held by the public at depository institutions; the assets of money market mutual funds; and certain other depository institution liabilities. The Federal Reserve affects the money stock chiefly by its influence over interest rates. When the Federal Open Market Committee lowers the target federal funds rate, the rate at which depository institutions purchase and sell overnight funds to one another in the market falls, and so do other short-term interest rates. Lower short-term market interest rates increase the attractiveness of the rates paid on deposits at commercial banks and other depository institutions because changes in these rates tend to lag changes in market rates. Consequently, the public tends to purchase the assets included in the money stock, and money growth increases. Conversely, when the FOMC raises the target federal funds rate, the federal funds rate increases, as do other short-term interest rates. The rates paid on assets included in the money stock become less attractive, and money growth slows.
For more information, see the current release of money stock
measures, on the Board of Governors' web site.
What is the discount rate?
The discount rate is the interest rate that an eligible depository institution is charged to borrow funds, typically for a short period, directly from a Federal Reserve Bank. By law, the board of directors, of each Reserve Bank sets the discount rate independently every fourteen days subject to the approval of the Board of Governors. Originally, each Reserve Bank set its discount rate to reflect the banking and credit conditions in its own District. Over the years, the transition from regional credit markets to a national credit market has gradually produced a national discount rate. As a result, the Federal Reserve maintains a uniform structure of discount rates across all Reserve Banks. For more information on the discount rate, see The Federal Reserve System: Purposes and Functions on the Board of Governors' web site.
The discount rate is the interest rate that an eligible depository institution is charged to borrow funds, typically for a short period, directly from a Federal Reserve Bank. By law, the board of directors, of each Reserve Bank sets the discount rate independently every fourteen days subject to the approval of the Board of Governors. Originally, each Reserve Bank set its discount rate to reflect the banking and credit conditions in its own District. Over the years, the transition from regional credit markets to a national credit market has gradually produced a national discount rate. As a result, the Federal Reserve maintains a uniform structure of discount rates across all Reserve Banks. For more information on the discount rate, see The Federal Reserve System: Purposes and Functions on the Board of Governors' web site.
How does the Federal Reserve maintain the stability of the financial system?
The Federal Reserve's roles in conducting monetary policy, supervising banks, and providing payment services to depository institutions help it maintain the stability of the financial system.
The Federal Reserve's roles in conducting monetary policy, supervising banks, and providing payment services to depository institutions help it maintain the stability of the financial system.
Using the monetary policy tools at its disposal, the Federal Reserve can promote an environment of price stability and reasonably damped fluctuations in overall economic activity that helps foster the health and stability of financial institutions and markets. The Federal Reserve also helps foster financial stability through the supervision and regulation of several types of banking organizations to ensure their safety and soundness. In addition, the Federal Reserve operates certain key payment mechanisms and oversees the operation of the payment system more generally, with the goal of strengthening and stabilizing the system.
The Federal
Reserve engages in all these activities on a routine
basis,
but the stabilization activities of a central bank are
especially evident and critical during periods of
financial
stress, such as those that occurred following the stock
market decline of October 1987, the international debt
crisis in the fall of 1998, and the terrorist attacks in
September 2001. In these instances, the Federal Reserve
promoted financial system stability by providing ample
liquidity (balances at the Federal Reserve) through large
open market purchases of securities (using short-term
repurchase agreements) and by extending discount window
loans to depository institutions. In unusual and exigent
circumstances, the Federal Reserve has the authority to
lend to individuals, partnerships, and corporations, but
it
has never done so.
Where can I obtain copies of the Federal Reserve's Monetary Policy Reports to Congress?
The Federal Reserve Board's semiannual Monetary Policy Reports to Congress are available on the Board of Governors' web site. To obtain paper copies of the report, contact the Board of Governors of the Federal Reserve System, Washington, DC 20551, Publications Fulfillment, phone (202) 452-3245.
The Federal Reserve Board's semiannual Monetary Policy Reports to Congress are available on the Board of Governors' web site. To obtain paper copies of the report, contact the Board of Governors of the Federal Reserve System, Washington, DC 20551, Publications Fulfillment, phone (202) 452-3245.
How do I locate a specific Federal Reserve research paper?
You may find Federal Reserve research papers in the Fed-in- Print, a searchable database located on the Federal Reserve Bank of San Francisco's website.
You may find Federal Reserve research papers in the Fed-in- Print, a searchable database located on the Federal Reserve Bank of San Francisco's website.
What is TALF?
TALF stands for Term Asset Backed Securities Loan Facility. The Federal Reserve announced the creation of TALF on November 25, 2008. TALF is a funding facility that issues loans with a term of up to five years to holders of eligible asset-backed securities (ABS). TALF is intended to assist the financial markets in accommodating the credit needs of consumers and businesses of all sizes by facilitating the issuance of ABS collateralized by a variety of consumer and business loans; it is also intended to improve the market conditions for ABS more generally. The Federal Reserve Board has authorized extensions of credit through the TALF until June 30, 2010, for loans collateralized by newly issued commercial mortgage backed securities (CMBS) and through March 31, 2010, for loans collateralized by all other TALF-eligible securities. For more information: http://www.federalreserve.gov/monetarypolicy/talf.htm
TALF stands for Term Asset Backed Securities Loan Facility. The Federal Reserve announced the creation of TALF on November 25, 2008. TALF is a funding facility that issues loans with a term of up to five years to holders of eligible asset-backed securities (ABS). TALF is intended to assist the financial markets in accommodating the credit needs of consumers and businesses of all sizes by facilitating the issuance of ABS collateralized by a variety of consumer and business loans; it is also intended to improve the market conditions for ABS more generally. The Federal Reserve Board has authorized extensions of credit through the TALF until June 30, 2010, for loans collateralized by newly issued commercial mortgage backed securities (CMBS) and through March 31, 2010, for loans collateralized by all other TALF-eligible securities. For more information: http://www.federalreserve.gov/monetarypolicy/talf.htm
What are primary dealers?
Primary dealers are banks and securities broker-dealers that trade in U.S. government securities with the Federal Reserve Bank of New York (FRBNY). On behalf of the Federal Reserve System, the FRBNY's Open Market Desk engages in these trades in order to implement monetary policy. The purchase of government securities in the secondary market by the Open Market Desk adds reserves to the banking system; the sale of securities drains reserves. Further information on primary dealers, together with a current list of designated primary dealers, is available on the Federal Reserve Bank of New York's website at: http://www.newyorkfed.org/aboutthefed/fedpoint/fed02.html
Primary dealers are banks and securities broker-dealers that trade in U.S. government securities with the Federal Reserve Bank of New York (FRBNY). On behalf of the Federal Reserve System, the FRBNY's Open Market Desk engages in these trades in order to implement monetary policy. The purchase of government securities in the secondary market by the Open Market Desk adds reserves to the banking system; the sale of securities drains reserves. Further information on primary dealers, together with a current list of designated primary dealers, is available on the Federal Reserve Bank of New York's website at: http://www.newyorkfed.org/aboutthefed/fedpoint/fed02.html
