Conducting the Nation's Monetary Policy

Through its monetary policy, the Fed influences the level of interest rates, which in turn affect employment, economic growth, and the general level of prices.

The link between monetary policy and the economy is bank reserves. Banks need reserves to meet required levels set by the Fed and to settle payments on behalf of their customers. By altering the supply of reserves available, the Fed can influence short-term interest rates, particularly the federal funds rate, which is the rate that banks charge each other for overnight loans of reserves.

How does the Fed alter the supply of available reserves? By going into the financial markets and buying and selling Treasury securities. When the Fed buys Treasury securities in the open market, it adds reserves to the banking system. Money is said to be "easy," and interest rates drop. Conversely, when the Fed sells Treasury securities in the open market, it reduces banks' supply of reserves. Money is then said to be "tight," and interest rates go up.

Decisions about these open-market operations are made by the Federal Open Market Committee (FOMC) . The 12-member Committee includes the seven Governors and five Reserve Bank presidents. Four of the five presidents serve on a rotating basis. The exception is the New York Fed's president, who is a permanent member of the Committee. The FOMC meets every six weeks in Washington, D.C. All Reserve Bank presidents, regardless of whether it's their turn on the FOMC, participate in the discussions, bringing a perspective shaped by economic conditions in their Districts.

Occasionally, to meet an unexpected need for reserves, an institution may borrow directly from its local Federal Reserve Bank. The rate of interest on these loans, jointly set by the Reserve Banks' boards and the Board of Governors, is called the discount rate.

Conducting the Nation's Monetary Policy

Fed Responsibilities

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