"The objective of monetary policy is to help the economy achieve full employment, price-level stability, and economic growth (McConnell & Brue, 2004, p. 276). The Federal Reserve Banks work to promote equilibrium within these areas to create prosperity throughout the country. The Federal Reserve Banks use securities and loans to commercial banks as assets and the reserves of member banks, Treasury deposits, and Federal Reserve Notes as liabilities to control monetary policy. The Feds have three tools to control the money supply; open markets, reserve ratios, and discount rates Controlling the money supply affects many macroeconomics factors such as unemployment, inflation and interest rates. "Monetary policy operates through a complex cause-effect chain; policy decisions affect commercial bank reserves; changes in reserves affect the money supply; changes in the money supply alter the interest rate; changes in the interest rate affect investment; changes in investment affect aggregate demand; changes in aggregate demand affect the equilibrium real GDP and the price level" (McConnell & Brue, 2004, p.
288). To better understand how monetary policy works to achieve the Federal Reserve's goals, this paper will identify the ways in which the money supply is controlled, how new money is created, and the combination of policy needed to achieve a balance between economic growth, low inflation, and a reasonable rate of unemployment.
The first method of controlling the money supply is referred to as open markets. According to the Federal Reserve Board (2003), "the Federal Reserve Board is the most important policy making body of the Federal Reserve System." The Federal Open Market Committee (FMOC) establishes objectives for the short term markets. These objectives have changed significantly throughout history. Since early 2000, the FMOC's goals focused on price stability and sustainable economic growth (The Federal Reserve Board, 2005). Open...