Topic 2: Monetary Policy

The Federal Reserve is responsible for regulating the U.S. monetary system and setting monetary policy. Monetary policy refers to what the Federal Reserve does to influence the amount of money and credit in the U.S. economy. Policy instruments that affect the quantity of money and credit affect interest rates (the cost of credit) and the performance of the U.S. economy.

The Federal Reserve’s three instruments of monetary policy are open market operations, the discount rate and reserve requirements. The Fed controls the money supply primarily through open-market operations.

Board of Governors of the Federal Reserve System. (n.d.). Retrieved from http://www.federalreserve.gov/

Based on the above summary and the detailed descriptions of monetary policy issues in the textbook (Chapter 34 and Chapter 36) discuss the following questions.

What are the expansionary monetary policy and contractionary monetary policy? What are their policy instruments? How are they used to deal with the inflationary gap and recessionary gap? Which do you think is more appropriate today?

If the Fed wants to increase aggregate demand, it can increase the money supply. If it does this, what happens to the interest rate and rate of inflation? Why might the Fed choose not to respond in this way?

Should monetary policy be made by rule rather than by discretion? Why?

The only thing backing up a nation’s currency (fiat money) in the modern world is faith in the government issuing it. If this is so, what should governments do to maintain a stable currency? How can the Central Bank (the Federal Reserve) build trust in the U.S. currency? What actions would undermine a currency?