It is essential the government does what is necessary to ensure the U.S. economy is stable. The welfare of the nation’s residents depends on a thriving and robust economy which promotes economic growth and equality while also keeping inflation under control. There are many ways the government takes action to maintain the health of the nation’s economy. One way the government does this is through monetary policy.
What is monetary policy?
The U.S. Federal Reserve, the nation’s central bank, utilizes a set of tools to control the overall supply of money in the national economy. This set of tools is known as monetary policy which aims to promote sustainable economic growth. The Federal Reserve’s actions affect how much money is available for consumers, banks, and businesses.
Also playing a role in monetary policy, the U.S Treasury Department is in charge of actually creating money. It is also responsible for collecting taxes, distribution of the governmental budget and issuing bonds, bills, and notes. The Treasury Department also provides the U.S. President with advice on economic and monetary policy.
How does the Fed influence money supply?
The Federal Reserve, also known as the Fed, influences money supply by buying and selling financial securities, most commonly U.S. Treasury bonds and mortgage-backed securities. These actions by the Fed aimed at promoting economic growth and stability are known as open market operations (OMO). The objective is to maintain a balance between an economy which is over-stimulated with money supply which could cause inflation and a stagnant economy that is not growing and may be shrinking.
Fed’s role in interest rates
The Fed sets the nation’s interbank interest rate, which is the benchmark interest rate at which banks will loan money to each other. This benchmark influences other interest rates in the economy, such as mortgage rates and consumer credit card rates. Increasing interest rates will slow down spending in the economy while lowering interest rates will encourage more spending which spurs economic growth.
Direction of monetary policy
Monetary policy which is more restrictive to growth, such as when the Fed sells securities or raises interest rates, is considered tightening of monetary policy. On the other hand, a less restrictive and more stimulative policy, such as when the Fed buys securities and lowers interest rates, is considered loosening of monetary policy.
Monetary policy effects on investments
As an investor it is a good idea to keep current on the latest developments in monetary policy implemented by the government. How monetary policy changes affect investments will depend on the type of investment assets and which direction the monetary policy moves are made. For example, more restrictive monetary policy usually results in downward pressure on values of stocks in general, especially stocks of companies which are more dependent on debt-financing for growth, such as technology sector stocks.
Speaking to a qualified financial advisor who has knowledge of financial markets can help you adjust your portfolio to better suit current monetary policy environments.