Search Penny Hill Press

Tuesday, February 26, 2013

Monetary Policy and the Federal Reserve: Current Policy and Conditions

Marc Labonte
Coordinator of Division Research and Specialist

The Federal Reserve (the Fed) defines monetary policy as the actions it undertakes to influence the availability and cost of money and credit. Because the expectations of market participants play an important role in determining prices and growth, monetary policy can also be defined to include the directives, policies, statements, and actions of the Fed that influence how the future is perceived. In addition, the Fed acts as a “lender of last resort” to the nation’s financial system, meaning that it ensures continued smooth functioning of financial intermediation by providing financial markets with adequate liquidity.

Traditionally, the Fed has implemented monetary policy primarily through open market operations involving the purchase and sale of U.S. Treasury securities. The Fed traditionally conducts open market operations by setting an interest rate target that it believes will allow it to fulfill its statutory mandate of “maximum employment, stable prices, and moderate long-term interest rates.” The interest rate targeted is the federal funds rate, the price at which banks buy and sell reserves on an overnight basis. This rate is linked to other short-term rates and these, along with inflation expectations, influence longer-term interest rates. Interest rates affect interestsensitive spending such as business capital spending on plant and equipment, household spending on consumer durables, and residential investment. Through this channel, monetary policy can be used to stimulate or slow aggregate spending in the short run. In the long run, monetary policy mainly affects inflation. A low and stable rate of inflation promotes price transparency and, thereby, sounder economic decisions by households and businesses.

Recently, in response to the financial crisis, direct lending became important once again and the Fed created a number of new ways for injecting reserves, credit, and liquidity into the banking system, as well as making loans to firms that are not banks. As financial conditions normalized, loans were repaid with interest and emergency lending programs have been wound down, with the exception of foreign central bank liquidity swaps.

Beginning in September 2007, in a series of 10 moves, the federal funds target was reduced from 5.25% to a range of 0% to 0.25% on December 16, 2008, where it now remains. In December 2012, the Fed pledged to maintain “exceptionally low rates” at least as long as unemployment is above 6.5% and inflation is low. With the federal funds target at the “zero lower bound,” the Fed has added additional monetary stimulus first through direct lending and, more recently, through purchases of Treasury and government-sponsored enterprise (GSE) securities. This practice is sometimes referred to as quantitative easing, which has tripled the size of the Fed’s balance sheet since the financial crisis began. On September 13, 2012, the Fed announced a new round of asset purchases, pledging to purchase $40 billion in GSE mortgage-backed securities per month until the labor market improves, as long as price stability is maintained. Coupled with $45 billion in monthly purchases of Treasury securities, the Fed’s balance sheet is now increasing by about $85 billion each month.

Congress has delegated responsibility for monetary policy to the Fed, but retains oversight responsibilities for ensuring that the Fed is adhering to its statutory mandate. H.R. 492 and S. 215 would switch to a single mandate of price stability. Congressional debate on Fed oversight has focused on audits by the Government Accountability Office (GAO). The Dodd-Frank Act enhanced the GAO’s ability to audit the Fed and required an audit of its emergency programs. H.R. 24, H.R. 33, and S. 209 would remove all remaining restrictions on GAO’s audit powers.

Date of Report: February 12, 2013
Number of Pages: 21
Order Number: RL30354
Price: $29.95

To Order:

RL30354.pdf  to use the SECURE SHOPPING CART


Phone 301-253-0881

For email and phone orders, provide a Visa, MasterCard, American Express, or Discover card number, expiration date, and name on the card. Indicate whether you want e-mail or postal delivery. Phone orders are preferred and receive priority processing.