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Monetary Control refers to policies that governments use in an attempt to stabilize their economies by indirectly influencing various economic aspects such as inflation and employment (Mathai). There are three standard instruments for monetary control utilized by the countries central banks thus open market operations, reserve requirements, and setting of discount rates.
Reserve requirements involve the Fed determining the amount of money that banks keep in the reserves at the end of the day. On the other hand, a discount control means increasing or decreasing the interest rates for banks borrowing from the reserve. The third mechanism, open market operations, which is the most commonly used involves selling or buying government issued securities. Monetary control policies provide mechanism for governments to ensure economic stability since they affect the basic aspects on an economy.
Open market operations are a quick and easy way of influencing market rates by the Reserve Bank because they instantaneously raise or reduce the funds available for lending by banks. The Fed in most cases employs open market operations since they provide short-term control of inflation through influencing the amount of money in circulation (Amadeo). Selling of securities by the Fed to banks reduces the amount of money available for lending while increasing the amount in the Federal Reserve Bank.
Subsequently, the sale of securities slows down the economy by reducing expenditure and mostly controls inflation (Balasubramaniam). Buying of securities from banks increases the money available for lending by banks and reduces the interest rates spurring investment and economic growth since there is the availability of surplus money in the economy. The process thereby influences the cost and amount of credit supply in the market.
The decision to purchase or sell securities by the Federal Reserve Bank is the responsibility of the Federal Open Markets Committee (FOMC). The FOMC comprises of a board of governors and five reserve bank presidents. The committee meets every six to eight weeks to examine or give directives on monetary policies to the Systems Open Market Account (SOMA) manager. The Fed website on "Open Market Operations" states that the FOMC delegates duties to the SOMA, which in turn is responsible for the "the desk" thus, the Trading Desk in charge of the execution of open market operations (Federal Bank of New York). Directives by the FOMC usually contain formulations of monetary policies that reflect the Fed’s desired rates that ensure economic stability.
Open market operations policies like any other monetary policies are crucial since they affect various aspects of the economy such as the GDP and employment rates. Fiscal policies have an aim of controlling the supply of money in an economy. According to the online article "Finance & Development,” the amount of money in the market influences the rate of interest; less supply increased the rates while more supply reduced the rates (Mathai). A country's Gross Domestic Product (GDP) is a fixed value, in the short-term monetary policies influence prices of products, but eventually, the supply of finance affects the production capacity. Therefore, fiscal policies have an impact on a country’s inflation rates and employment through changing the demand and production processes.
Monetary policies by the Fed provide a means to cushion and maintain stability during the times of fluctuations. The Fed uses three mechanisms for monetary control, although, open market operation has significant impact on monetary control. The Fed prefers the use of open market operations since they influence the short-term and long-term economic aspects. The policies affect the microeconomic and macroeconomic aspects that influence business cycles. Essentially, the policies have impact on recession, recovery, growth, and decline of business activities thus influencing the state of the economy.
Amadeo, Kimberly. "What Is Being Done To Control Inflation?". About.com Money. N. p., 2016. Web. 14 May 2016.
Balasubramaniam, Kesavan. "How Do Open Market Operations Affect The U.S. Money Supply? | Investopedia". Investopedia. N. p., 2006. Web. 14 May 2016.
Federal Reserve Bank of New York. "Open Market Operations". Newyorkfed.org. N.p., 2016. Web. 14 May 2016.
Mathai, Koshy. "Finance & Development". Finance & Development | F&D. N.p., 2016. Web. 14 May 2016.
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