The Federal Reserve, commonly known as the Fed, is the central bank of the United States. Being a central bank, it serves multiple important functions within the economy. Kavan Choksi points out that one of the most vital functions of the Fed is to use monetary policy for the purpose of promoting economic stability. The Federal Reserve’s goals for monetary policy, as defined by Congress, involve promoting maximum employment and price stability.
Kavan Choksi sheds insights into the monetary policy decisions of the Federal Reserve
The Federal Reserve sets the stance of monetary policy in the United States in order to influence short-term interest rates and overall financial conditions. This is done with the goal of moving the economy towards stable prices and maximum employment. The monetary policy decisions of the Fed impact the financial lives of all Americans. It not only influences the spending decisions people make as consumers, but also influences the spending decisions of businesses.
Even though Congress specifies the goals for monetary policy, it has also provided the Fed with operational independence. This flexibility helps make sure that monetary policy decisions can be directed toward the longer term, shall be based on objective analysis and data, and ultimately serve the interests of all Americans.
Kavan Choksi mentions that the Federal Open Market Committee (FOMC) is the monetary policy-making arm of the Federal Reserve. This committee typically meets about eight times per year in Washington, D.C. These two-day meetings involve briefings by economists, policy discussions, review of economic data and financial conditions, as well as a vote on the setting of monetary policy. This vote is basically about making a decision on whether the FOMC will adjust its target range for the federal funds rate.
The federal funds rate simply is the interest rate banks charge each other for overnight loans. The Fed sets a target range for where it wants the interest rates charged to fall within. The setting of this range is essentially a tool used by the Fed to communicate its monetary policy position.
The federal funds rate basically is a very specific short-term interest rate which involves the transfer of funds between banks that maintain accounts with the Federal Reserve Bank. These accounts are known as reserve balance accounts. When commercial banks in the United States may need money in their reserve accounts for cash-flow reasons, they typically choose to borrow from banks that have excess funds in their reserve accounts. This is known as the federal funds market. Banks who lend funds ideally act as suppliers of reserves in the federal funds market. On the other hand, banks that borrow funds tend to act as demanders of reserves in the federal funds market. The federal funds rate is not really “set” by the Fed, but rather determined by the lenders and borrowers in the federal funds market.
The FOMC carries out monetary policy by setting the target range for the federal funds rate. They subsequently implement policy by using certain monetary policy tools that help make sure that the federal funds rate stays within the target range.