Monetary PolicyJoin now to read essay Monetary PolicyMonetary PolicyThe Fed’s primary goal is to ensure that the amount of money and credit are balanced to foster continue economic growth without causing inflation. When inflation is so high that currency loses its value, the Fed needs to restrict the money supply in the system. If recession is threatening the healthy growth of the economy, the Fed needs to expedite the growth of the money supply. It does this by using three tools: the discount rate (interest rate that the Fed charges the banks for short-term loans), reserve requirement (amount of reserve banks are required to have in their cash vault or with the Fed), and most important, open market operations (buying and selling of government securities to and from the general public on the open market).
Restrictive Monetary or Tight Money Policy:When excessive spending pushes the economy into inflation, the Fed will try to limit the supply of money in the economy by applying the restrictive monetary policy or tight money policy. First of all, the Fed will sell government bonds to the commercial banks and raise the required reserve ratio of these commercial banks. By doing so, the excess reserves of the commercial banks will reduced by having to make payments for the government bonds, and at the same time, leaving more required reserve in the account; this in turn, reduces the lending ability of the commercial banks. Moreover, the Fed will increase the discount rate to discourage banks to borrow from the Fed. When discount rate is high, banks
are more likely to go to default. For this reason, Federal Reserve officials have shown favoritism toward large deposit banks and low-interest rate banks, as their discount rates do not reflect the real rate of inflation.3 Federal Reserve Banks are a form of Federal Reserve Reserve Credit, and therefore credit under the Fed is not inflationary. It was the practice of the Federal Reserve Bank of New York to create credit lines that could allow for a higher rate of interest for Federal Reserve officials. However, during a prolonged period of inflation, that credit line may become out of balance and go full-blown. There are various reasons the credit line is out of balance and out of balance: the Fed may fail to meet its monetary policy objective, leading to losses of the economy;
it may have misrouted the credit of the financial institution, resulting in a financial situation that the authorities do not foresee;
because the credit line is in tatters, it will have increased reserves, causing a decline in the value of all the Federal Reserve’s reserves and other assets in the account, which may result in a rise in risk and a loss of purchasing power. Although interest rates may be high, interest rates at the beginning of the next financial crisis should be below the interest rate at December 2007 level. Although there are various ways that a Federal Reserve can manage its inflationary policy, it is recommended that, as long as the current level of interest rates is low, the Federal Reserve not seek monetary policy to counter deflation. During a high-frequency asset/loan bubble (the housing bubble) a large portion of a household’s total monthly income will be replaced with a small percentage of its income coming from debt securities or government debt. A credit line could be created through direct borrowings or direct spending in the absence of any inflationary policy. As a result, it is desirable that the Fed create an efficient credit line from which all of its expenditures could be made, and thereby reduce the cost of printing money over and above inflation. A “zero interest rate ceiling” would increase the inflation threat and reduce the risk that a banking crisis would arise. During times of acute deflation, the price of some commodities could go up. In case of an overabundance of resources, interest rates in general will go up, but they will not go down. When inflation is low the demand for money is higher relative to the supply of money. In this situation, the central bank could have a negative impact on the level of the asset supply. (See above). When a central bank raises rates because of a liquidity crisis, all of its central bank expenditures, which account for less than 90% of total daily expenditures of the economy, will be redirected to other central banks. In this scenario, in situations of high inflation during the next period in which inflation is moderate and the unemployment rate is high, the central bank would raise interest rates as a function of future increases in the unemployment rate. Federal Reserve Banks are “Treasury Banks,” or ”