FEDERAL RESERVE PAPER

Summary of the Report by the Federal Reserve Chairman



Summary of the Report by the Federal Reserve Chairman

Introduction

U.S. monetary policy affects all kinds of economic and financial decisions people make in this country—whether to get a loan to buy a new house or car or to start up a company, whether to expand a business by investing in a new plant or equipment, and whether to put savings in a bank, in bonds, or in the stock market, for example. Furthermore, because the U.S. is the largest economy in the world, its monetary policy also has significant economic and financial effects on other countries.

A. Purpose and Function of Money

Bernanke (2009) mentions that the object of monetary policy and money is to influence the performance of the economy as reflected in such factors as inflation, economic output, and employment. It works by affecting demand across the economy—that is, people's and firms' willingness to spend on goods and services.

While most people are familiar with the fiscal policy tools that affect demand—such as taxes and government spending—many are less familiar with monetary policy and its tools. Monetary policy is conducted by the Federal Reserve System, the nation's central bank, and it influences demand mainly by raising and lowering short-term interest rates (Bernanke, 2009).

B. The Central Bank Manages a Nation's Monetary

The Federal Reserve System (called the Fed, for short) is the nation's central bank. It was established by an Act of Congress in 1913 and consists of the Board of Governors in Washington, D.C., and twelve Federal Reserve District Banks (for a discussion of the Fed's overall responsibilities, see The Federal Reserve System: Purposes and Functions).

The Congress structured the Fed to be independent within the government--that is, although the Fed is accountable to the Congress and its goals are set by law, its conduct of monetary policy is insulated from day-to-day political pressures. This reflects the conviction that the people who control the country's money supply should be independent of the people who frame the government's spending decisions. Three structural features give the Fed independence in its conduct of monetary policy: the appointment procedure for Governors, the appointment procedure for Reserve Bank Presidents, and funding (Bernanke, 2009).

C. Started Direction of Recent Monetary Policy in US

Monetary policy has two basic goals: to promote "maximum" sustainable output and employment and to promote "stable" prices. These goals are prescribed in a 1977 amendment to the Federal Reserve Act.

What do maximum sustainable output and employment mean?

In the long run, the amount of goods and services the economy produces (output) and the number of jobs it generates (employment) both depend on factors other than monetary policy. These factors include technology and people's preferences for saving, risk, and work effort. So, maximum sustainable output and employment mean the levels consistent with these factors in the long run (Bernanke, 2009).

But the economy goes through business cycles in which output and employment are above or below their long-run levels. Even though monetary policy can't affect either output or employment in the ...