When it comes to the U.S. economy, the Federal Reserve has a very important role to play. Whether you realize it or not, its decisions affect you. In this episode of The Economic Lowdown podcast series, you’ll learn about how the Federal Reserve uses monetary policy to influence the economy.
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The Federal Reserve Bank of St. Louis presents The Economic Lowdown. Episode 20—Monetary Policy.
The Federal Reserve System, often simply called “the Fed,” is the central bank of the United States.
What do you know about the Federal Reserve? If you’re like most people, probably not much. Janet Yellen is the current chair of the Federal Reserve Board of Governors. Most people don’t know that either. A 2014 Pew Research poll found that only 24 percent of those surveyed correctly picked her from a list of four names as the current chair. If people simply guessed, the outcome would be about the same. Yet, in that same year, according to Forbes magazine, Janet Yellen was the most powerful women in the United States.1
When it comes to the U.S. economy, the Federal Reserve has a very important role to play. Whether you realize it or not, its decisions affect you. In this Economic Lowdown podcast, you’ll learn about how the Federal Reserve uses monetary policy to influence the economy.
Monetary policy refers to the actions the Federal Reserve takes to promote a strong economy. Specifically, Congress has given the Federal Reserve two objectives: maximum employment and price stability. These two objectives are often referred to as the dual mandate, and here’s how those objectives promote a strong economy:
So, how does the Fed influence the economy to meet its dual mandate?
It uses monetary policy to influence the demand for goods and service in the economy. Let’s take a look at two specific economic conditions and what the Fed is likely to do.
First, imagine the economy is in recession, which means that the economy is contracting, or getting smaller—it’s producing fewer goods and services than it did in the past period. When this happens, the unemployment rate is usually on the rise and inflation might be falling below the Fed’s 2 percent objective. In other words, the economy is moving away from its potential. In such a case, the Fed might use monetary policy to lower interest rates. Here’s why.
However, at some point, spending by households and firms might exceed the economy’s ability to produce goods and services. At this point, inflation might start to rise above the Fed’s 2 percent objective. How can the Fed reduce the inflation rate?
Now do you see now how the Federal Reserve’s decisions can affect you? The Fed uses monetary policy to satisfy its dual mandate set by Congress—price stability and maximum employment. During a recession, when the unemployment rate rises or inflation falls below its target, the Fed uses monetary policy to decrease interest rates to encourage consumers and businesses to spend. The increased spending encourages businesses to produce more and hire more employees. When inflation rises too far above the 2 percent target, the Fed uses monetary policy to increase interest rates to discourage consumers and businesses spending, which reduces inflationary pressures.
So, the next time you hear on the news that interest rates are going up or down, you’ll have a good idea why.
Thanks for listening.
1 Who’s in Charge of the Fed? Don’t bank on public knowing the answer. Pew Research Center. October 6, 2014. Accessed December 13, 2016. http://www.pewresearch.org/fact-tank/2014/10/06/whos-in-charge-of-the-fed-dont-bank-on-public-knowing-the-answer/ [back to text]