Central Banking and Monetary Policy

Where would you look to find the most important macroeconomic policymakers today? In the White House? Or in the Congress? Perhaps in the United Nations or the World Bank? Surprisingly, the answer is that you Outlook in an obscure marble building in Washington that houses the Federal Reserve System. It is here that the Federal Reserve (or “Fed”) sets the level of short-term interest rates, thereby profoundly affecting financial markets, wealth, output, employment, and prices. Indeed, the Fed’s influence spreads not only throughout the 50 states but even, through financial and trade linkages, to virtually every corner of the world.

The Federal Reserve’s central goal is low and stable inflation. It also seeks to promote steady growth in national output, low unemployment, and orderly financial markets. If output is growing rapidly and inflation is rising, the Federal Reserve Board is likely to raise interest rates, as this puts a brake on the economy and reduces price pressures If the economy is sluggish and business is languishing, the Fed may consider lowering interest rates, a move which will give a boost to aggregate demand, increase output, and reduce unemployment. Every major country has a central bank that is responsible for managing its monetary affairs. This .chapter will help you understand the. Federal Reserve’s central role in the U.S. economy. Figure 26-1 shows the role of central .banking in the economy and depicts its relationship to the banks, financial markets, and interest rates. Section A surveys how the Fed uses its instruments-bank reserves, the discount rate, and other tools to determine the money supply and affect interest rates. Section B then analyzes the impact of monetary policy on the macro economy.

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