Monetary policy

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Federal Reserve System actions to influence the availability and cost of money and credit as a means of helping to promote high employment, economic growth, price stability, and a sustainable pattern of international transactions.

Monetary policy is policy enacted by a government or government agency with the aim of controlling the money supply.

In the United States, monetary policy is made by the Federal Reserve Bank and operates using three main tools:

  • The reserve ratio
  • The discount rate
  • Open-market operations

The Reserve Ratio

The reserve ratio is the ratio of money deposited in a bank that the bank is required to keep on hand. This amount of reserves is to ensure that banks can meet withdrawal demand and also prevents banks from becoming too leveraged.

The Discount Rate

The discount rate is the rate at which the Federal Reserve Bank will lend money to individual banks. The Fed is a lender of last resort and banks generally meet reserve shortfalls by borrowing from other banks; borrowing from the Fed can be seen as a bellwether of insolvency.

Open-Market Operations

The Fed's open-market committee can buy or sell Treasury Bonds to cause money to flow toward or away from the government. These sales or purchases are known as open-market operations.