Monetary Policy Fundamentals

Introduction:
The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve that determines monetary policy. The FOMC is consisted of board of governors between members and reserve bank presidents. Monetary policy is the action the central bank uses to either (1) increase or (2) decrease money supply. When the FOMC wants to increase the money supply, they would choose expansionary policies, while to decrease the supply, they would choose contractionary policies.

The three tools that can be implemented are open market operations, change in reserve ratios, and a change in the discount rate. Open Market Operations refers to the buying and selling of government securities. Reserve Ratio refers to the required percentage banks must have in cash. Discount rate refers to the interest rate that banks and other institutions use when receiving loans from the Federal Reserve.

Fundamentals vs. Reality
In the past we have seen the following statements to be true:
1. Contractionary Monetary Policy is very effective to fight off inflation, decrease money supply, and control pricing in the market.
2. Expansionary Monetary Policy is very effective when combined with good fiscal policy. Expansionary Monetary Policy is very limited when fiscal policy is absent. Essentially, when in recession, Expansionary Monetary Policy is the painkiller used after surgery, where fiscal policy, is the actual surgery to remove the problem.

Contractionary Policy:
If the country is fighting fast growing inflation prices, the FOMC would decrease the money supply. Under this scenario, the Federal Reserve would do the following:
1. For open market operations, the Federal Reserve would sell government bonds.
2. The Federal Reserve would increase the reserve ratio.
3. The Federal Reserve would increase the discount rate.

As a result, money supply will fall. The effects are the following:
1. Interest rates rise.
2. Investment spending decreases, which consequently decreases aggregate demand.
3. Decrease in aggregate demand may decrease the consumption component of Real GDP.

Expansionary Policy:
If the country is fighting recession or very slow growth, the FOMC would increase the money supply. Under this scenario, the Federal Reserve would do the following:
1. For open market operations, the Federal Reserve would buy government bonds.
2. The Federal Reserve would decrease the reserve ratio.
3. The Federal Reserve would decrease the discount rate.

As a result, money supply would increase. The effects are the following:
1. Interest rates decrease.
2. Investment spending increases, which consequently increases aggregate demand.
3. Increase in aggregate demand may increase the consumption component of Real GDP.

In our current environment:
We believe that the Federal Reserve did a good job in getting the economy out of recession. But we have failed sustainable growth because government officials lacked to promote bipartisanship agreements, consequently, having an absence of fiscal policy.

We reiterate that when combating inflation and cutting money supply, the FOMC actions are very effective. But to combat unemployment, we need the comprehensive approach of having effective fiscal and monetary policies. As of now, we only have one