The Federal Reserve (Fed) is an organization in the US, the job of which is to maintain the stability and the growth of the economy by stabilizing the prices and proving full employment opportunity. From the past records, it is clear that the Fed has been performing its operations by doing the manipulation of the short term interest rates or by engaging on the OMO (open market operation) or by making adjustments to the reserve requirements. Also there have been some new tools developed by the Fed, so that they are able to stand against the inevitable economic crisis.
Now here is an elaboration of the Fed’s tool which they use for influencing the economy.
This is one of the first tools that are used by the Fed and also the other central banks from around the world. In the practice of manipulating the interest rates, its value is either raised or lowered to either slow down or to spur the various economic activities and also to control the inflation. This is because when the interest rates are lowered, the interest on loan too becomes low which encourages the individuals to spend more since now they can borrow more. This way when savings decline, more money is spent. This in turn increases the total supply of the money in the market. Now this may also lead to inflation. Thus one must not overdo the whole manipulation of the interest rates.
Open market operations
The open market operation involves the buying or the selling of the treasury bonds. This activity is performed in the open market and is again another major tool used by the Fed to influence the economy. The practice of the OMO involves the manipulation of the interest rates by either increasing or decreasing the total supply of the money and also affecting the interest rates.
This is another great tool used by the Fed so as to influence the economic activites. In this the organization has the ability to make adjustments other than reserve requirements of the bank that determines the level of reserve any particular bank should be holding as compared to the specific deposit liabilities. The bank should hold a fixed percentage of the specified deposits that completely depends upon the reserves ratio which is required. This deposit should be held in the vault cash or with the fed’s deposits.
This is yet another important tool used by the Fed which is to influence the market perception. This tool is the most complicated of them all. This is because the whole idea of influencing the market perception revolves around influencing the perception of the investor. And this is clearly not an easy task given the extent to which the economy is transparent.
Therefore depending upon the circumstances of the economy, the fed tend to use any one of the above mentioned practice and eventually the economy gets stabilized.