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Therefore it can be seen that the Fed indirectly manipulates interest
rates through its Monetary Policy, which increases (easing) or reduces
(tightening) the amount of money in the economy. Over the years the
Fed has become so adept at establishing the Monetary Policy that it can
achieve desired interest rate levels with pinpoint accuracy. So even
though the Fed does not directly change the interest rates, its influence
over the interest rates makes it seem that it does. That is why you may
hear in the news that Fed raised the interest rates, or it lowered the
interest rates, or it left the interest rates unchanged.
Monetary Policy Implementation
The Fed achieves its Monetary Policy objectives through three
actions:
1. Open Market Operations — Most banks or financial
institutions buy and sell government securities (e.g., Treasury Bills,
Treasury Notes) as part of their investment strategies. Government
securities are originally obtained through government auctions
handled by the reserve banks. When the Fed sees a need to loosen its
Monetary Policy, it purchases (through its brokers) such securities from
the banks or the government and in return increases the reserves of
those particular banks, accordingly giving them more credit to work
with (basically, the Fed injects money into the banks). Conversely when
the Fed sees fit to tighten the Monetary Policy, it sells the securities on
the open market. As buyers (you and me) pay for these securities the
reserves of their banks are reduced accordingly because we must
withdraw money from our accounts to buy the securities, resulting in
less available cash for those banks and thus less money in public. This
is the Fed’s favorite method of controlling the available cash (or credit)
in the economy. …
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