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Monetary policy plays an important role in today's economy. The role of monetary policy is to strike a balance among the key macroeconomic variables in the changing times of today. The importance of this paper is to learn how monetary policy affects our money supply and what tools the Federal Reserve uses to control the money supply. One will also learn how the changes in the tools that the Federal Reserve uses affect the GDP, inflation rate, unemployment, and interest rates. The most appropriate monetary polices that the Federal Reserve uses to help control the economy are also discussed.
The supply of money consists of Federal Reserve notes, coins, and checkable deposits. Money supply is created by the U.S. Bureau of Engraving, which produces the Federal Reserve notes, U.S. Mint, which produces coins, and banks, thrifts, and loan officers who create checkable deposits. Checkable deposits make up more than half of the nation's money supply. They are created by the purchase of government bonds from the public and the issuance of loans. The banks limit the creation of checkable deposits by the amount of currency reserves that they feel obligated, or required by law, to keep. Although people might think there should be an investigation with the banks, thrifts, and loan officers for creating checkable deposits, the Federal Reserve relies on these institutions to create such an important component of the nation's money supply (McConnell & Brue, 2004)
Four tools exist that the Federal Reserve uses to control the money supply. Those tools consist of the federal funds rate (FFR), discount rate (DR), required reserve ratio (RRR), and the volume of open market operations (OMO). These sam ...