The Federal Reserve?s Monetary Policy is the most important function of the Fed and is probably the most used policy in macroeconomics. (Colander p.333). This paper will use The Monetary Policy Report submitted to the Congress on July 20, 2004 and Macroeconomics by David Colander to discuss the state of the economy, concerns of the Federal Reserve, and the stated direction of recent monetary policy.
The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals. The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy. The Federal Reserve controls the three tools of monetary policy- open market operations, the discount rate and reserve requirements. Open market operations, purchases and sales of U.S. Treasury and federal agency securities, are the Federal Reserve's principal tool for implementing monetary policy.
The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility; the discount window. The Federal Reserve Banks offer three discount window programs to depository institutions: primary credit, secondary credit, and seasonal credit, each with its own interest rate.
Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. The Board of Governors of the Federal Reserve System is not responsible for the discount rate and reserve requirements; and the Federal Open Market Committee is responsible for open market operations.
Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate. The federal funds rate is the interest...