U.S. Monetary Policy

1 . Monetary policy

In the United States , Monetary Policy is administered by the Federal Open Market Committee , which comprises the Board of Governors of the Federal Reserve System and the Reserve Bank Presidents (The Federal Reserve Board . Monetary policy is a system used by the government in to regulate the economy by controlling the growth of the money supply (Colander C . et al 1994 ,

6 . Nowadays monetary policy is the most important system used to control the economy

Basically monetary policy is a method used to control the rate of

inflation . Inflation is caused by an independent increase in money supply . Money supply consists of notes , coins and bank deposits Logically the strongest enterprises that determine the money supply are the banks . Therefore if the government wants to determine the rate of growth in money supply , he should influence the credit creation carried out by banks with the aid of interest rates , through open market operations (Waud N . R . et al 1992 ,

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In this respect , in 1998 in the United Kingdom , the Monetary Policy Committee of the Bank of England was established to control the level of interest rates in lieu with government objectives and budgets . Likewise as already stated the Reserve Bank in conjunction with the Board of Governors of the Federal Reserve System control the monetary policy of the United States

Now let us examine the general effect that changes on interest rates have on the economy

1 .1 Effect of interest rates

If inflation in an economy is higher than targeted by the government the Reserve Bank /Bank of England will use monetary policy to control the growth of money supply by raising the repo rate . This increase will lead to an immediate effect on the money market rates , by leading to an increase in short-term interest rates that banks charge on overdrafts Being a profit-oriented organization , banks will then change the interest rates they pay on deposits (Waud N . R . et al 1992 ,

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In turn , an increase in the repo rate will also affect the capital market both of loan stocks and equities . With respect to loan stocks the effect of such an increase in short-term interest rates depends on the expectations of the market . For example , if there is a general expectation by the market that short-term interest rates will rise again , the long-term interest rates will probably also rise (Waud N . R et al 1992 ,

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If short-term and long-term interest rates increase , they will have an adverse effect on equity . A rational investor is one that invests in securities with a positive net present value . Net present value is calculated after considering a discounting rate . If interest rates increase , these will increase the discounting rate by a higher percentage and will thus lead to a fall in the value and price of securities . This will eventually direct a shift of funds from the capital market to the money market . Investors will prefer to leave money...