monetary policy affects all kinds of economic and financial decisions people make in this country—whether to get a loan to buy a new house or car or to start up a company, whether to expand a business by investing in a new plant or equipment, and whether to put savings in a bank, in bonds, or in the stock market, for example. Furthermore, because the U.S. is the largest economy in the world, its monetary policy also has significant economic and financial effects on other countries.
The object of monetary policy is to influence the performance of the economy as reflected in such factors as inflation, economic output, and employment. It works by affecting demand across the economy—that is, people’s and firms’ willingness to spend on goods and services.
While most people are familiar with the fiscal policy tools that affect demand—such as taxes and government spending—many are less familiar with monetary policy and its tools. Monetary policy is conducted by the Federal Reserve System, the nation’s central bank, and it influences demand mainly by raising and lowering short-term interest rates.
This booklet provides an introduction to U.S. monetary policy as it is currently conducted by answering a series of questions:
How is the Federal Reserve structured?
What are the goals of U.S. monetary policy?
What are the tools of U.S. monetary policy?
How does monetary policy affect the U.S. economy?
How does the Fed decide the appropriate setting for the policy instrument?
How is the Federal Reserve structured?
The Federal Reserve System (called the Fed, for short) is the nation’s central bank. It was established by an Act of Congress in 1913 and consists of the Board of Governors in Washington, D.C., and twelve Federal Reserve District Banks (see the map; for a discussion of the Fed’s overall responsibilities, see The Federal Reserve System: Purposes and Functions).
The Congress structured the Fed to be independent within the government—that is, although the Fed is accountable to the Congress and its goals are set by law, its conduct of monetary policy is insulated from day-to-day political pressures. This reflects the conviction that the people who control the country’s money supply should be independent of the people who frame the government’s spending decisions.
What makes the Fed independent?
Three structural features give the Fed independence in its conduct of monetary policy: the appointment procedure for Governors, the appointment procedure for Reserve Bank Presidents, and funding.
Appointment procedure for Governors
The seven Governors on the Federal Reserve Board are appointed by the President of the United States and confirmed by the Senate. Independence derives from a couple of factors: first, the appointments are staggered to reduce the chance that a single U.S. President could “load” the Board with appointees; second, their terms of office are 14 years—much longer than elected officials’ terms.
Appointment procedure for Reserve Bank Presidents
Each Reserve Bank President is appointed to a five-year term by that Bank’s Board of Directors, subject to final approval by the Board of Governors. This procedure adds to independence because the Directors of each Reserve Bank are not chosen by politicians but are selected to provide a cross-section of interests within the region, including those of depository institutions, nonfinancial businesses, labor, and the public.
Funding
The Fed is structured to be self-sufficient in the sense that it meets its operating expenses primarily from the interest earnings on its portfolio of securities. Therefore, it is independent of Congressional decisions about appropriations.
monetary policy affects all kinds of economic and financial decisions people make in this country—whether to get a loan to buy a new house or car or to start up a company, whether to expand a business by investing in a new plant or equipment, and whether to put savings in a bank, in bonds, or in the stock market, for example. Furthermore, because the U.S. is the largest economy in the world, its monetary policy also has significant economic and financial effects on other countries.
The object of monetary policy is to influence the performance of the economy as reflected in such factors as inflation, economic output, and employment. It works by affecting demand across the economy—that is, people’s and firms’ willingness to spend on goods and services.
While most people are familiar with the fiscal policy tools that affect demand—such as taxes and government spending—many are less familiar with monetary policy and its tools. Monetary policy is conducted by the Federal Reserve System, the nation’s central bank, and it influences demand mainly by raising and lowering short-term interest rates.
This booklet provides an introduction to U.S. monetary policy as it is currently conducted by answering a series of questions:
How is the Federal Reserve structured?
What are the goals of U.S. monetary policy?
What are the tools of U.S. monetary policy?
How does monetary policy affect the U.S. economy?
How does the Fed decide the appropriate setting for the policy instrument?
How is the Federal Reserve structured?
The Federal Reserve System (called the Fed, for short) is the nation’s central bank. It was established by an Act of Congress in 1913 and consists of the Board of Governors in Washington, D.C., and twelve Federal Reserve District Banks (see the map; for a discussion of the Fed’s overall responsibilities, see The Federal Reserve System: Purposes and Functions).
The Congress structured the Fed to be independent within the government—that is, although the Fed is accountable to the Congress and its goals are set by law, its conduct of monetary policy is insulated from day-to-day political pressures. This reflects the conviction that the people who control the country’s money supply should be independent of the people who frame the government’s spending decisions.
What makes the Fed independent?
Three structural features give the Fed independence in its conduct of monetary policy: the appointment procedure for Governors, the appointment procedure for Reserve Bank Presidents, and funding.
Appointment procedure for Governors
The seven Governors on the Federal Reserve Board are appointed by the President of the United States and confirmed by the Senate. Independence derives from a couple of factors: first, the appointments are staggered to reduce the chance that a single U.S. President could “load” the Board with appointees; second, their terms of office are 14 years—much longer than elected officials’ terms.
Appointment procedure for Reserve Bank Presidents
Each Reserve Bank President is appointed to a five-year term by that Bank’s Board of Directors, subject to final approval by the Board of Governors. This procedure adds to independence because the Directors of each Reserve Bank are not chosen by politicians but are selected to provide a cross-section of interests within the region, including those of depository institutions, nonfinancial businesses, labor, and the public.
Funding
The Fed is structured to be self-sufficient in the sense that it meets its operating expenses primarily from the interest earnings on its portfolio of securities. Therefore, it is independent of Congressional decisions about appropriations.
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