Proper Essay Example About The Federal Reserve: Monetary Policy And Its Effects

The money supply of a certain nation is determined by the monetary policy of its central bank. The Federal Reserve is the central bank of the U.S. A. Moreover; monetary policy refers to the methods central banks use to increase or decrease the amount of money held by banks. The central bank can increase the money supply by changing discount rates, reducing bank reserves or buying government securities. Selling government securities or increasing the banks’ deposit reserves will contract or limit money supply.
The Federal Reserve utilizes monetary tools to control the amount of money and credit available in the U.S. One means it adopts is by setting reserve ratios that determine the amount of money financial institutions can hold in reserve against deposits in bank accounts. Another tool is setting the discount date by raising or lowering the short-term interest rates that banks pay on short-term loans from the Fed. The Fed could also engage in open-market operations by buying or selling government bonds to increase or decrease the amount of money circulating in the economy.
When money is deposited into a bank, the bank holds a percentage of the money in its reserve and invests or loans out the other. Money multiplier refers the wholesome amount in cash that a bank can lend as a result of its corresponding cash strength attributed to deposits made by its customers. It is a ratio that shows the extent to which an increase and decrease in bank deposits corresponds to increase or decrease in money supply.
If the Fed lowers interest rates or buys out government bonds, it translates to an increase in money supply, and this will enhance economic activity. A rise in discount rates will reduce the amount available for banks to lend out or invest. If the Fed sells government bonds or reduces interest rates, it means the money in circulation reduces thereby decreasing the cash required to fund economic activities.