Monetary policy - What? Why? How?

What?

What is monetary policy? Monetary policy is basically the control of the money supply and interest rates to influence inflation and other macro-economic variables. The principal emphasis currently is on using interest rates, as control of the money supply was found to be very difficult in the 'monetarist era' of the early 1980s. Since its founding in 1913, the Federal Reserve has been relatively independent of the Federal Government and free to take the actions thought necessary.

Why?

Why do we need monetary policy? The level of inflation is considered to be one of the key economic targets. Keeping inflation low means a stable environment for people and business, creating conditions that support economic growth. This in turn should minimize the level of unemployment. Stable, low inflation helps the economy grow for long periods and avoid booms and recessions. Monetary policy is considered the most effective way to achieve this.

How?

How is monetary policy carried out? Setting interest rates is the responsibility of the twelve member Federal Open Market Committee (FOMC). Seven of the members are the Governors of the Federal Reserve; the president of the NY District Bank of the Federal Reserve, and four presidents of other district banks of the Federal Reserve are also members. The committee is headed by the Chair of the Board of Governors. The FOMC has eight scheduled meetings a year to assess the state of the economy and decide whether it is most appropriate to increase, decrease or leave interest rates the same. Market intervention is then used to ensure that interest rates are maintained at the level set by the FOMC.