Monetary Policy Actions Proposal

MonetaryPolicy Actions Proposal

MonetaryPolicy Actions Proposal

Monetary policy refers to the useof money supply and credit to address issues of inflation andunemployment in the economy as well as promoting a sustainableeconomic growth (Mankiw, 2007). The Federal Reserve uses three mainmonetary policy tools to affect the money supply which in turn helpsto stabilize the economy by correcting problems with spending,employment and prices. First, the Fed purchases bonds in the openmarket during periods of recession (FRB: Beige Book, 2015). Thishelps to increase the reserves that the banks hold. Hence the bankswill have more money to lend leading to a decrease in interest rates.With lower interest rates, firms and consumers will have incentivesto borrow so as to make purchases and this increases aggregatedemand. Increased aggregate has an effect on improving employment.

Second, during periods of rapidinflation, the Fed reduces money supply by selling bonds in the openmarket (FRB: Beige Book, 2015). Reduction of money supply helps toincrease the reserve requirement which in turn raises the interestrates. With high interest rates, the firms and consumers are lesslikely to borrow for purposes of purchasing commodities. This has anoverall effect of lowering inflation. The buying and selling ofbonds by the Fed is referred to as open market operations. The twomonetary policy tools act in opposite directions.

Finally, the Fed also lowers thediscount rate during periods of recession in order to make commercialbanks more willing to borrow from the Fed (FRB: Beige Book, 2015). With a lower discount rate, the commercial banks will have incentivesto borrow from the Fed and make loans available to firms andconsumers at lower interest rates. Thus firms and consumers will haveincentives to borrow and spend, increasing aggregate demand.

References

FRB:Beige Book (2015) Boardof Governors of the Federal Reserve System.Retrieved 9 November

2015, fromhttp://www.federalreserve.gov/monetarypolicy/beigebook/

Mankiw,N. (2007). Macroeconomics.New York: Worth Publishers