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Introduction
Monetary policy “refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit as a means of helping to promote national economic goals” (Board of Governors of the Federal Reserve System, 2008). Monetary policies play an important role in the decision making policy and directly impact GDP, unemployment, inflation, and interest rates. “Mainstream economists generally agree that monetary policy is the best month-to-month stabilization instrument for the U.S. economy” (McConnell & Brue, 2004, p. 228). The Federal Reserve Bank (Fed) has to understand when and how to impact the economy on various instrument at its disposal. “The goal of monetary policy is to help the economy achieve price stability, full employment, and economic growth” (McConnell and Brue, 2004, p. 288).
Stable prices in the long run are a precondition for maximum sustainable output growth and employment as well as moderate long-term interest rates. When prices are stable and believed likely to remain so, the prices of goods, services, materials, and labor are undistorted by inflation and serve as clearer signals and guides to the efficient allocation of resources and thus contribute to higher standards of living. Board of Governors of the Federal Reserve System, 2008 The Fed uses three instruments to impact the supply of money: open-market operations, ratio requirement, and discount rate. All of the instruments impact interest rates and therefore, the increase and decrease of the money supply within the economy.
One of the instruments at the Federal Reserve’s di ...