Kavan Choksi / カヴァン・チョクシ Sheds Light on The Fed's Tools for Influencing the Economy
The Federal Reserve
(The Fed) is responsible for maintaining a stable and growing economy in the
U.S. through price stability and full employment. As Kavan Choksi / カヴァン・チョクシ says, historically
the Fed has achieved these goals by adjusting reserve requirements, engaging in
open market operations (OMO) and manipulating short-term interest rates.
The Fed also had developed tools to fight economic crises that emerged
during the 2007 subprime crisis.
Kavan Choksi / カヴァン・チョクシ talks
about the tools used by the Fed to influence the United States economy
The very first tool
used by the Fed to influence the economy is the manipulation of short-term
interest rates. This tool, in fact, is used by central banks around the world.
It involves raising and lowering interest rates for the purpose of slowing or
spurring economic activity and controlling inflation. It becomes less lucrative
to save and cheaper to borrow money when interest rates are low, and encourages
individuals and businesses to spend more as well. More funds are borrowed,
savings decline, and more money is spent as interest rates decline. As
borrowing increases, so does the total supply of money in the economy
increases.
Lower interest rates,
however, may also increase inflation, as the total supply of goods and services
is essentially finite in the short term. When more dollars are chasing that
finite set of products, prices invariably go up. If inflation gets too
high, then the economy may experience a significant negative impact.
Open market
operations (OMO) are another major tool available to the Fed, and involve the
Fed buying or selling Treasury bonds in the open market. It involves the Fed
buying or selling Treasury bonds in the open market. OMO can impact interest
rates, as well as increase or decrease the total supply of money. By swapping
out bonds in exchange for cash to the general public when it buys bonds in the
open market, the Fed can increase the money supply in the economy. It lowers
the money supply by removing cash from the economy in exchange for bonds, as it
sells bonds.
As Kavan Choksi / カヴァン・チョクシ says, the
Federal Reserve may even adjust the reserve requirements of the banks. This
essentially determines the level of reserves a bank must hold in comparison to
the deposit liabilities specified. On the basis of the required reserve ratio,
the bank may hold a certain percentage of the specified deposits in vault cash
or deposits with the Federal Reserve banks.
Influence on market
perceptions is the final tool used by the Fed to affect markets. This is
somewhat a bit more complicated as it relies on the concept of influencing the
perceptions of the investors, which is not always easy due to the transparency
of the United States economy. Doing so may involve any type of public
announcement from the Fed regarding the economy. The Fed may say that the
economy is growing too fast and hence it is worried about inflation, which
would logically mean that an interest rate increase is needed to cool the
economy.
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