US monetary policy - Term Paper Example

When the Fed wants to “expand the money supply” (create money), it steps in and buys bonds from these dealers with newly-issued dollars acquired by the Fed for the cost of writing them into an account on a computer screen. The Federal Reserve is overseen by board of governors based in Washington, which is a government body (Solomon 1996). This board of governors comprise of 7 members appointed by the president of the United States of America, each of them has the capacity to serve for 14 years.

All this members must pass through senate for confirmation and are eligible for reappointment. The chairman is the head of the board being deputized by the vice chairman. Both the chairman and deputy are appointed by the president and must pass through senate for approval (Solomon 1996). Ben Bernanke is the current chairman; he took over from Alan Greenspan. The most common tool used by the Federal Reserve is the buying and selling of government securities in order to increase or reduce the amount of money in the banking system and this is done through an open market (Timberlake 1993).

When they buy securities, they pump money into the banking system and accelerate growth while sales of securities siphon money from the system. Federal Reserve's aim is to use this technique to adjust the federal funds rate, that is, the rate at which banks borrow from each other (Timberlake 1993). . the ones required by the law or rather set by the Federal Reserve board of governors can use the money to bring those changes back to stability (Timberlake 1993). The board of directors of each reserve bank sets the discount rate every 14 days.

It's considered the last resort for banks, which usually borrow from each other. The Fed uses the discount rate to check the supply of available funds, which will in effect have impact on inflation and in extension interest rates (Degen 1987). If the available money is abundant, there is more likelihood of inflation occurring. It will become more expensive to borrow from Federal Reserve if interest rate is increased. Short term interest rate will, therefore, be increased by lower supply of money and the opposite is true.

Quantitative Easing” (QE) is a kind of operations within markets that assist the Federal Reserve achieve its policy targets (Degen 1987). QE involves open market operations that are not different from the way the Federal Reserve often operates in its quest to attain certain policy objectives. When Federal Reserve changes their target interest rate, it is doing so in order to involve open market operations that alter reserves in the banking system so as to get to its preferred rate.   Open market operations often include moves such as adjusting the existing reserves in the banking system so as to assist reaching a target interest rate.

 Many people believe that QE operates to achieve its objectives in ways that are different from standard monetary policy, e.g. influencing demand for loans, the wealth effect and interest rate channels (Wells 2004). Much of the misconception is also due to the untruth that QE helps to fund the US government or is equivalent to “money printing”.  This is not true. The main