How Does Federal Reserve Control the Money Supply

Topics: Monetary policy, Federal Reserve System, Central bank Pages: 3 (619 words) Published: April 24, 2014
How does Federal Reserve Control the Money Supply?
Federal Reserve or simply “the Fed” is an independent entity whose main goal is to provide the nation with a safer, more flexible, and more stable monetary and financial system. It is the central bank of the United States that influences the monetary policy by controlling the money supply and cost of money in able to give the economy full employment, low inflation rate, and stable prices. Manipulating money supply is a very powerful tool use by the Fed to stabilize the economy. So how does the Federal Reserve control the money supply? The Fed uses three different methods to increase or decrease the amount of money supply in the economy. The first method is by conducting open market operations, which affects the federal funds rate. In open-market operations, the Fed buys and sells government securities in the open market. If the Fed wants to increase the money supply, it buys government bonds. This supplies the securities dealers who sell the bonds with cash, increasing the overall money supply. Conversely, if the Fed wants to decrease the money supply, it sells bonds from its account, thus taking in cash and removing money from the economic system. Open-market operations are the most important tool that the Fed can use to influence the money supply. Perfect example was during the recession of 2007 – 2009. The primary tool that the Fed used early during the current crisis was to cut the Federal Funds rate. The Fed initially conducts open market operations by buying and selling short-term Treasury instruments and then later on widened the range of securities to include agency and mortgage-backed bonds. The Fed had raised rates to 5.25% in June 2006 and rates remained at that level until the first rate cut (to 4.75%) in September 2007. The Fed continued to cut rates six more times until rates were at 2% in April 2008.  The Fed then paused until the Lehman crisis and then cut rates twice in October 2008 and once...
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