The Federal Reserve — America’s central bank — plays a vital role in maintaining economic stability. Its mission, set by Congress, is to ensure maximum employment, stable prices, and moderate long-term interest rates.
To achieve this, the Fed uses a set of powerful monetary policy tools that influence borrowing costs, inflation, and the overall flow of money in the economy.
Key Monetary Policy Tools
1. Federal Funds Target Rate
The Fed’s main lever is the federal funds rate — the rate at which banks lend reserves to each other overnight.
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Raising rates makes borrowing costlier, slowing spending and reducing inflation.
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Lowering rates boosts lending and stimulates economic activity.
2. Interest on Reserve Balances (IORB)
Banks earn interest on reserves held at the Fed.
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A higher IORB encourages banks to keep money parked, tightening the money supply.
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A lower IORB pushes banks to lend more, expanding the money supply.
3. The Discount Rate
This is the interest rate the Fed charges banks for short-term loans from its “discount window.”
4. Overnight Reverse Repurchase Agreements (ON RRP)
The Fed temporarily sells securities and buys them back the next day to control short-term rates.
5. Open Market Operations (OMO)
By buying or selling government securities, the Fed adjusts the level of reserves in the banking system.
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Purchases inject cash, increasing liquidity.
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Sales withdraw cash, tightening conditions.
Why the Fed Changes Rates
When inflation rises too quickly, the Fed raises rates to slow spending.
When growth weakens or unemployment rises, it cuts rates to stimulate the economy.
The Bottom Line
Today, the Fed primarily influences the economy through:
Together, these tools help the Fed maintain price stability, employment growth, and healthy long-term interest rates — the foundation of a stable U.S. economy.
