Definition: Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity. Show Description: In India, monetary policy of the Reserve Bank of India is aimed at managing the quantity of money in order to meet the requirements of different sectors of the economy and to increase the pace of economic growth. The RBI implements the monetary policy through open market operations, bank rate policy, reserve system, credit control policy, moral persuasion and through many other instruments. Using any of these instruments will lead to changes in the interest rate, or the money supply in the economy. Monetary policy can be expansionary and contractionary in nature. Increasing money supply and reducing interest rates indicate an expansionary policy. The reverse of this is a contractionary monetary policy. For instance, liquidity is important for an economy to spur growth. To maintain liquidity, the RBI is dependent on the monetary policy. By purchasing bonds through open market operations, the RBI introduces money in the system and reduces the interest rate. The Fed, as the nation’s monetary policy authority, influences the availability and cost of money and credit to promote a healthy economy. Congress has given the Fed two coequal goals for monetary policy: first, maximum employment; and, second, stable prices, meaning low, stable inflation. This “dual mandate” implies a third, lesser-known goal of moderate long-term interest rates. The Fed’s interpretations of its maximum employment and stable prices goals have changed over time as the economy has evolved. For example, during the long expansion after the Great Recession of 2007–2009, labor market conditions became very strong and yet did not trigger a significant rise in inflation. Accordingly, the Fed de-emphasized its prior concern about employment possibly exceeding its maximum level, focusing instead only on shortfalls of employment below its maximum level. In this newer interpretation, formalized in the FOMC’s August 2020 “Statement on Longer-Run Goals and Monetary Policy Strategy, Federal Reserve Board of Governors, August 27, 2020. The Federal Reserve sets U.S. monetary policy and the New York Fed plays a central role in implementing it. The Fed’s economic goals prescribed by Congress are to promote maximum employment, stable prices, and moderate long-term interest rates. The Federal Open Market Committee (FOMC or Committee) is responsible for monetary policy decisions to achieve these goals. The goals of maximum employment and price stability, commonly known as the “dual mandate”, create the conditions for moderate long-term interest rates. The FOMC determines the appropriate position or “stance” of monetary policy, which reflects how “accommodative” (encouraging economic growth) or “restrictive” (slowing economic growth) it should be. Once the FOMC determines the appropriate stance of policy, the Committee issues directives to the Open Market Trading Desk at the New York Fed (Desk) to implement the policy. Monetary policy works by influencing short-term interest rates to affect the availability and cost of credit in the economy and, ultimately, the economic decisions businesses and households make. Monetary policy can also affect financial conditions more broadly as measured by financial asset prices such as stock and bond prices, longer term interest rates, and the exchange rate of the U.S. dollar against foreign currencies. This all affects economic activity and, ultimately, the Federal Reserve’s key goals of maximum employment and price stability. The framework for implementing monetary policy includes two key parts:
In addition, the FOMC at times issues forward guidance, or communications about the economic outlook and likely future course of monetary policy to shape market expectations about interest rates and financial conditions more broadly. Forward guidance is typically communicated through FOMC statements and policymaker remarks. Targeting the Federal Funds Rate The FOMC announces the target range for the federal funds rate after each of the Committee’s eight meetings per year. The federal funds rate is the interest rate on transactions between banks and other eligible entities to borrow and lend their account balances at the Federal Reserve on an overnight, unsecured basis. These account balances, or reserve balances, are deposits held by eligible institutions for multiple reasons, including to meet payment obligations, manage their liquidity risk, and comply with associated regulatory ratios. With an ample supply of reserves in the banking system, the Federal Reserve controls the federal funds rate primarily through the setting of administered rates, and active management of the supply of reserves is not required. On a daily basis, the New York Fed publishes the Effective Federal Funds Rate (EFFR), which is calculated as a volume-weighted median of the previous business day’s overnight federal funds transactions. The Federal Reserve sets two administered rates at levels to help keep the federal funds rate well within the target range and support smooth functioning of short-term funding markets. Together, these rates help establish a floor under overnight interest rates, including the EFFR, below which banks and other money market participants should not be willing to lend. Modest adjustments to these rates within the target range may occur to help support rate control, but they do not represent a change in policy stance.
Liquidity backstop tools play an important role in supporting the effective implementation of monetary policy by limiting the potential for pressures in overnight funding markets to push the EFFR above the FOMC’s target range.
Changes in the size or composition of the balance sheet are an important part of the monetary policy implementation framework. At the direction of the FOMC and on behalf of the System Open Market Account (SOMA)—the Federal Reserve’s portfolio of securities—the Desk purchases securities in the open market. There are different reasons that the FOMC may direct the Desk to conduct asset purchases.
The FOMC may also direct the Desk to reduce the size of the balance sheet, which can tighten monetary policy. This includes limiting reinvestment of proceeds from maturing securities or selling securities. For example, starting in June 2022, the FOMC directed the Desk to begin allowing Treasury and agency mortgage-backed securities holdings to mature without reinvestment up to specified amounts, which guided the pace of balance reduction. To support effective open market operations, the Desk lends eligible Treasury and agency debt securities owned by the Federal Reserve on an overnight basis. Also, to support its operational readiness to implement future directives from the FOMC, the Desk conducts very small purchases or sales of securities from time to time across a range of operation types. These operations do not represent a change in the stance of monetary policy. Federal Funds Rate Targeting Amid Ample Reserves The approach to controlling the federal funds rate changed during and after the Global Financial Crisis of 2008–2009 in a few key ways:
The Pre-Crisis Implementation Framework Before the Global Financial Crisis, the Federal Reserve used a scarce reserves system to implement monetary policy. In this system, the FOMC achieved its federal funds rate target by directing the Desk to actively manage the supply of reserves in the banking system to meet the demand for reserves at the intended federal funds rate. Unlike today’s framework for monetary policy implementation, the pre-crisis framework did not pay banks interest on their reserve balances. That incentivized banks to hold just enough reserves to meet their reserve requirements and avoid overdrafts. Under the pre-crisis framework, there was a relatively low aggregate level of reserves in the banking system, prompting banks to rely on borrowing and lending reserves in an active interbank federal funds market to meet their individual reserve needs. The Desk would purchase and sell Treasury securities, on an outright basis or through repurchase and reverse repurchase agreements, to bring the supply of reserves in line with the estimated level needed for the EFFR to print close to the FOMC’s target. Small changes in the aggregate supply of reserves through market operations could cause meaningful changes in the level of rates in the federal funds market. Securities purchases added reserves to the system, putting downward pressure on short-term interest rates; securities sales drained reserves, putting upward pressure on short-term rates. Who is responsible for the monetary policy?The Federal Reserve sets U.S. monetary policy and the New York Fed plays a central role in implementing it. The Fed's economic goals prescribed by Congress are to promote maximum employment, stable prices, and moderate long-term interest rates.
Who is responsible for monetary policy quizlet?"The Fed" central bank of the US and government agency primarily responsible for the nation's monetary policy. Government policy that attempts to manage the economy by controlling the money supply and thus interest rates.
What is the Fed's role in monetary policy?The Federal Reserve conducts the nation's monetary policy by managing the level of short-term interest rates and influencing the availability and cost of credit in the economy. Monetary policy directly affects interest rates; it indirectly affects stock prices, wealth, and currency exchange rates.
What are the main monetary policies?The main monetary policy instruments available to central banks are open market operation, bank reserve requirement, interest rate policy, re-lending and re-discount (including using the term repurchase market), and credit policy (often coordinated with trade policy).
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