How Does the Fed Use Its Monetary Policy Tools to Influence the Economy?

The Federal Reserve has a congressional mandate to promote maximum employment and price stability. The May issue of Page One Economics explains how the Federal Open Market Committee (FOMC) conducts monetary policy by setting the target range for the federal funds rate and how the Fed uses its policy tools to steer the federal funds rate into the FOMC’s target range.

What is the federal funds rate and why is it so important? The federal funds rate is a very specific short-term interest rate – it’s the interest rate banks charge each other for overnight loans in the federal funds market. The federal funds rate is important because it influences many other interest rates in the economy.

Over time, the FOMC has moved the federal funds rate target range up and down as it promotes its dual mandate goals of maximum employment and price stability.

The following tools are used by the Federal Reserve to help ensure the federal funds rate stays within the target range as set by the FOMC:

  • Interest on Reserve Balances
  • The Overnight Reverse Repurchase Agreement Facility
  • The Discount Window
  • Open Market Operations

Teachers: Visit the Reading Q&As in our Econ Lowdown Teacher Portal to find the high school/college teacher editions (including an answer key) for this issue; to assign an online version of the student materials; and to collect student scores on the questions.

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