What is Monetary Policy?
One way of describing monetary policy is by the change in something that the central bank can directly manipulate, such as money supply or a short-term interest rate known as the federal funds rate. The federal funds rate is the interest rate at which banks lend their excess reserve balances at the Federal Reserve to other banks that have reserves below what is required by the system. Policy is considered to be "expansionary" if it increases the size of the money supply or decreases the interest rate. On the other hand, it is said to be "contractionary" if it reduces the size of the money supply or raises the interest rate.
Another way of describing monetary policy is by the intended effects on the economy. According to Chapter 2 of the Federal Reserve's document, The Federal Reserve System: Purposes and Functions, "in the short run some tension can exist between the two goals" and "in such circumstances, those responsible for monetary policy face a dilemma and must decide whether to focus on defusing price pressures or on cushioning the loss of employment and output." Thus, monetary policy is described as "accommodative" if the central bank is looking to spur economic growth, "neutral" if the central bank is neither attempting to increase growth nor fight inflation, or "tight" if intended to reduce inflation." (For more, see How The Federal Reserve Was Formed and Formulating Monetary Policy.)
How Does the Federal Reserve Accomplish its Goals?
The Fed can't control inflation or influence output and employment directly. Instead, it affects them indirectly through the use of the following three tools of monetary policy:
- Open market operations
- The discount rate
- Reserve requirements
Using these three tools, the Federal Reserve influences the supply and demand for reserve balances and in this way alters the federal funds rate.
In addition, the Federal Reserve can use "moral suasion" by pressuring certain market participants to act in a particular manner or through "open mouth operations" where the Fed states what goal it will be focusing on in hopes of getting the market to build these future monetary actions into expectations and thus increase the effectiveness of the current monetary actions.
Raising or lowering interest rates affects demand for goods and services. The Federal Reserve states that "changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output and prices of goods and services." (To learn how this works in more detail, see the Federal Reserve Bank of San Francisco's About The Fed page.)
Why Does Monetary Policy Matter to the Stock Market?
Monetary policy influences output and employment in the short run and can be used to smooth out the business cycle, but in the long run output and employment are dependent upon capital efficiency, labor productivity, savings and risk tolerance. For example, when demand weakens and there's a recession, the Fed can temporarily stimulate the economy and help push it back toward its long-run level of output by lowering interest rates. The Fed will have some difficulty managing monetary policy perfectly but the monetary forces they put into play can either put wind in the sails of business or create a headwind that they must fight against. (For related reading, see How Does the Government Influence the Securities Market?)
How can economic policy be dirty?Can you explain why do the fed is most powerful organization that influence the market??
And why all traders/business man follow the fed??
You know that fed is belongs to USA and USA have dirty Economic policy...
How can economic policy be dirty?
Traders follow Fed's decision, because they influence the currency market - that is a fact. If they ignore such important events as Fed's QE increase or QE tapering, their trading results will be poorer.
All things is possible, they could be liar to the markets, so their sentiment still be good. they make US company still good, because all their media is fake and very dirty.....