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1 1 (January 9, 2023)

handle is hein.crs/govekdj0001 and id is 1 raw text is: Congressional Research Service informing the legislative debate since 1914 Updated January 9, 2023 Introduction to U.S. Economy: Monetary Policy The Federal Reserve (Fed), the nation's central bank, is responsible for monetary policy. This In Focus explains how monetary policy works. Typically, when the Fed wants to stimulate the economy, it makes policy more expansionary by reducing short-term interest rates. When it wants to make policy more contractionary or tighter, it raises rates. Since March 2022, the Fed has been raising interest rates in an attempt to reduce inflation. For background on the Fed and its other responsibilities, see CRS In Focus IF10054, Introduction to Financial Services: The Federal Reserve. Federal Open Market Committee Monetary policy decisions are made by the Federal Open Market Committee (FOMC), whose voting members are the Fed's seven governors, the New York Federal Reserve Bank president, and four other Reserve Bank presidents, who vote on a rotating basis. The FOMC is chaired by the Fed chair. FOMC meetings are regularly scheduled every six weeks, but the chair sometimes calls unscheduled meetings. After these meetings, the FOMC statement announcing any changes to monetary policy is released. Statutory Goals In 1977, the Fed was mandated to set monetary policy to promote the goals of maximum employment, stable prices, and moderate long-term interest rates (12 U.S.C. §225a). The first two goals are referred to as the dual mandate. The dual mandate provides the Fed with discretion on how to interpret maximum employment and stable prices and how to set monetary policy to achieve those goals. There are no formal repercussions when goals are not met. Since 2012, the FOMC has explained its mandate in its Statement on Longer-Run Goals. It defines stable prices as 2% inflation, measured as the annual percent change in the personal consumption expenditures price index. In the Fed's view, maximum employment is not directly measurable and changes over time owing largely to nonmonetary factors that affect the structure and dynamics of the labor market. The Fed aims to meet its target on average over time, offsetting periods of inflation below 2% with periods above 2%. Federal Funds Rate In normal economic conditions, the Fed's primary instrument for setting monetary policy is the federal funds rate (FFR), the overnight interest rate in the federal funds market, a private market where banks lend to each other. The FOMC sets a target range for the FFR that is 0.25 percentage points wide and uses its tools to keep the actual FFR within that range. HwDes Monetary Policy Affect the Changes in the FFR target lead to changes in interest rates throughout the economy, although these changes are mostly less than one-to-one. Changes in interest rates affect overall economic activity by changing the demand for interest- sensitive spending (goods and services that are bought on credit). The main categories of interest-sensitive spending are business physical capital investment (e.g., plant and equipment), consumer durables (e.g., automobiles, appliances), and residential investment (new housing construction). All else equal, higher interest rates reduce- and lower rates increase-interest-sensitive spending. Interest rates also influence the demand for exports and imports by affecting the value of the dollar. All else equal, higher interest rates increase net foreign capital inflows as U.S. assets become more attractive relative to foreign assets. To purchase U.S. assets, foreigners must first purchase U.S. dollars, pushing up the value of the dollar. When the value of the dollar rises, the price of foreign imports declines relative to U.S. import-competing goods, and U.S. exports become more expensive relative to foreign goods. As a result, net exports (exports less imports) decrease. When interest rates fall, all of these factors work in reverse and net exports increase, all else equal. Business investment, consumer durables, residential investment, and net exports are all components of gross domestic product (GDP). Thus, if expansionary monetary policy causes interest-sensitive spending to rise, it increases GDP in the short run. This increases employment, as more workers are hired to meet increased demand for goods and services. An increase in spending also puts upward pressure on inflation. Contractionary monetary policy has the opposite effect on GDP, employment, and inflation. Most economists believe that although monetary policy can permanently change the inflation rate, it cannot permanently change the level or growth rate of GDP, because long-run GDP is determined by the economy's productive capacity (the size of the labor force, capital stock, and so on). If monetary policy pushes demand above what the economy can produce, then inflation should eventually rise to restore equilibrium. When setting monetary policy, the Fed must take into account the lags between a change in policy and its effect on economic conditions so that rate changes can be made preemptively. The Fed's Balance Sheet Like any company, the Fed holds assets on its balance sheet that are equally matched by the sum of liabilities and capital. The Fed's assets are primarily Treasury securities, mortgage-backed securities, loans, repurchase agreements (repos), and other assets acquired from emergency

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