Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 7

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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