The Federal Reserve Monetary policy can be defined as the as the ability of the Federal Reserve Bank to influence the accessibility of money and credit. Federal Reserve Bank applies a monetary policy to determine prices and economic growth (Galí, 5). It has the responsibility, through its monetary policy, to ensure maximum employment, price stability and moderate long-term interests. Federal Reserve performs its duty by setting the aim for the federal fund rate as well as the rate at which the banks borrow and lend. The Federal Reserve is currently using normalization policy. In the period beginning December 16, 2015, Federal Reserve wanted to tighten the monetary policy; therefore, they raised the federal fund rates. The policy increased the rates by 0.25% or 0.5% at a time while maintaining the current size of the balance sheet (Galí, 3).
The Federal Reserve and the Federal Open Market committee used the monetary policy tools to achieve the target rate. The supply and demand for money in the financial institution determines federal funds rate in an open market operation. When the Federal Open Market Committee raises the federal funds rate, the government will sell its securities hence withdrawing money from banks’ reserve accounts. Less supply of money in the banking system exerts pressure on the federal funds rate hence reducing consumers and business spending. Second, for the case of discount rates, it is set above the federal funds rate target. When the Feds set the discount rates above the federal funds rate, financial institutions cannot turn to the Federal Reserve banks for funding before they exhaust other alternatives. Therefore, they are left with less money to lend. Third, for the case of reserve requirement, the Fed will use the predictable nature of the bank reserve market to set the federal funds rate through open market operation. The rise in the federal funds rate was due to sells of government securities and a decrease in bank reserve.
Ultimately, regarding my personal finances, the current monetary policy will restrict me from taking major loans to purchase a car or a house. The higher the federal funds rate, the more expensive it becomes for financial institutions to borrow money. Therefore, financial institutions will have less money supply and this will cause the market interest rates to rise. As a consumer, my spending power will reduce hence I will be less likely to receive a major loan.
Galí, Jordi. Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework and Its Applications. Princeton University Press, 2015.
“Monetary Policy Report”. Federal Reserve Bank.10 Feb. 2016. Web. 17 Mar. 2016. <http://www.federalreserve.gov/monetarypolicy/mpr_20160210_part2.htm>.
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