User talk:BigK HeX/SandboxMPUS

Monetary policy concerns the actions of a central bank or other regulatory authorities that determine the size and rate of growth of the money supply. In the United States, the Federal Reserve is in charge of monetary policy, and implements it primarily by performing operations that influence the short term interest rates.

Money supply
The money supply has different components, generally broken down into "narrow" and "broad" money. The Federal Reserve controls only the most narrow form of money, physical cash outstanding along with the reserves of banks throughout the country (known as M0 or the monetary base). Broad money includes money held in deposit balances in banks and other forms created in the financial system. Basic economics also teaches that the money supply shrinks when loans are repaid; however, the money supply will not necessarily decrease depending on the creation of new loans and other effects. Other than loans, investment activities of commercial banks and the Federal Reserve also increase and decrease the money supply. Discussion of "money" often confuses the different measures and may lead to misguided commentary on monetary policy and misunderstandings of policy discussions.

Federal Reserve
Monetary policy in the United States is determined and implemented by the United States Federal Reserve System, commonly referred to as the Federal Reserve. Established in 1913 to provide central banking for the public, the Federal Reserve is a quasi-public institution; technically a private corporation and independent in its day-to-day operations, but legislatively accountable to Congress, and, according to some, "controlled by the publicly-appointed Board of Governors;" The Federal Reserve is managed by an independent  board of directors appointed jointly by its member banks, and Congress. The Chairman of the Board is generally considered the have the most important position, followed, in importance, by the New York Reserve Bank's president. The Federal Reserve System is primarily funded by interest collected on their portfolio of securities from the US Treasury; nearly all the interest the Federal Reserve collects is paid to the government each year.

The Federal Reserve has three main mechanisms for manipulating the money supply. It can buy or sell treasury securities. Selling securities has the effect of reducing the monetary base (because it accepts money in return for purchase of securities). Purchasing treasury securities increases the monetary base (because it pays out hard currency in exchange for accepting securities). Secondly, the discount rate can be changed. And finally, the Federal Reserve can adjust the reserve requirement, which can affect the money multiplier.

Assuming a closed economy, where foreign capital or trade does not affect the money supply, when interest rates go down, money supply increases. Businesses and consumers have a lower cost of capital and can increase spending and capital improvement projects. This encourages short-term growth. Conversely, when interest rates go up, the money supply falls, increasing the cost of capital and leading to more conservative spending and investment. The Federal reserve increases interest rates to combat inflation.

Fractional reserve banking
When money is deposited in a bank, it can then be lent out to another person. If the initial deposit was $100 and the bank lends out $100 to another customer the money supply has increased by $100. However, because the depositor can ask for the money back, banks have to maintain minimum reserves to service customer needs. If the reserve requirement is 10% then, in the earlier example, the bank can lend $90 and thus the money supply increases by only $90. The reserve requirement therefore acts as a limit on this multiplier effect.

Money creation
Currently, the US government maintains over 800 billion US dollars in cash money (primarily Federal Reserve Notes) in circulation throughout the world, whereas in 1959, there was less than 30 billion dollars; going back even further, the money supply was less than 20 billion dollars in 1933. Below is an outline of the process which is currently used to control the amount of money in the economy. The amount of money in circulation generally increases to accommodate money demanded by the growth of the country's production. The process of money creation usually goes as follows:
 * 1) In order to raise additional money to cover excess spending, Congress increases the size of the National Debt by issuing securities typically in the form of a Treasury Bond  (see Treasury security). It offers the Treasury security for sale, and someone pays cash to the government in exchange. Banks are often the purchasers of these securities.
 * 2) The 12-person Federal Open Market Committee, that consist of the heads of the Federal Reserve System, meets eight times a year to determine how they would like to influence the economy.  They create a plan called the country's "monetary policy" which sets targets for things such as interest rates.
 * 3) Banks go through their daily transactions.  Of the total money deposited at banks, significant and predictable proportions often remain deposited, and may be referred to as "core deposits." Banks decide to make use of the bulk of "non-moving" money (their stable deposit base) by loaning it out. Banks have a legal requirement to keep a certain percentage of money on-hand at all times.
 * 4) According to the estimates in its plan for the US Economy, the Federal Reserve places an order for money with the US Treasury Department.  The Treasury Department sends these requests to its operations called the Bureau of Engraving and Printing (to make  dollar bills) and the Bureau of the Mint (to stamp the coins).
 * 5) The US Treasury sells this newly printed money to the Federal Reserve for the cost of printing.  This is about 6 cents per bill for any denomination.  Aside from printing costs, the Federal Reserve must pledge collateral (typically government securities such as Treasury bonds) to put new money, which does not replace old notes, into circulation.
 * 6) Every business day, the Federal Reserve System engages in Open market operations. If the Federal Reserve wants to increase the money supply, it will buy securities (such as US Treasury Bonds) from the banks in exchange for dollars. If the Federal Reserve wants to decrease the money supply, it will sell securities to the banks in exchange for dollars.
 * 7) By means of open market operations, the Federal Reserve affects the free reserves of commercial banks in the country.  Anna Schwartz explains that "if the Federal Reserve increases reserves, a single bank can make loans up to the amount of its excess reserves, creating an equal amount of deposits".
 * 8) Since banks have more free reserves, they may loan out the money, because holding the money would amount to accepting the cost of foregone interest and commercial banks generally act to avoid such opportunity costs.  When a loan is granted, a person is generally granted the money by adding to the balance on their bank account.
 * 9) This is how additional broad money is created --- through bank loans; as written in a particular case study, "as banks increase or decrease loans, the nation's money supply increases or decreases."  Once granted these additional funds, the recipient has the option to withdraw physical currency (dollar bills and coins) from the bank, which will reduce the amount of money available for further on-lending (and money creation) in the banking system.

Though the Federal Reserve authorizes and distributes the currency printed by the Treasury (the primary component of the monetary base), the broad money supply is primarily created by commercial banks through the money multiplier mechanism. As indicated above, the monetary base has increased by more than 750 billion dollars since 1933. One textbook summarizes the process as follows: "The Fed" controls the money supply in the United States by controlling the amount of loans made by commercial banks. New loans are usually in the form of increased checking account balances, and since checkable deposits are part of the money supply, the money supply increases when new loans are made ... This type of money is convertible into cash when depositors request cash withdrawals, which will require banks to limit or reduce their lending. As loans from private banks are the primary tool used to expand the money supply, the vast majority of the broad money supply throughout the world represents current outstanding loans of various debtors to banks. A very small amount of US currency still exists as "United States Notes", which have no meaningful economic difference from Federal Reserve notes. The official designation for the currency distributed by the Federal Reserve are "Federal Reserve Notes."

Monetary policy
In 2005, the Federal Reserve held approximately 9% of the national debt as assets against the liability of printed money. In previous periods, the Federal Reserve has used other debt instruments, such as debt securities issued by private corporations. During periods when the national debt of the United States has declined significantly (such as during the Clinton administration), monetary policy and financial markets experts have studied the practical implications of having "too little" government debt: both the Federal Reserve and financial markets use the price information, yield curve and the so-called risk free rate extensively. Experts are hopeful that other assets could take the place of National Debt as the base asset to back Federal Reserve notes, and Alan Greenspan, long the head of the Federal Reserve, has been quoted as saying, "I am confident that U.S. financial markets, which are the most innovative and efficient in the world, can readily adapt to a paydown of Treasury debt by creating private alternatives with many of the attributes that market participants value in Treasury securities." In principle, the government could still issue debt securities in significant quantities while having no net debt, and significant quantities of government debt securities are also held by other government agencies.

Although the US government receives income overall from seigniorage, there are costs associated with maintaining the money that is printed by the government. Specifically, the ecological economist Herman Daly explains "Over 95% of our money supply [in the United States] is created by the private banking system (demand deposits) and bears interest as a condition of its existence." The interest costs are owed by those that have borrowed from US banks for their loan--the loan is required in order for money to be injected into the economy, and even simply for the existing supply of broad money to be maintained (as noted in "Step 9" in the above process). In compensation, depositors of funds in the banking system are paid interest (or provided other services, such as checking account privileges or physical security for their "cash"). Economist Eric Miller criticizes an association that Daly makes between GDP and the money supply, concluding that money is created in the banking system in response to demand, which justifies its cost.

Growth of the money supply is balanced against growth in interest-bearing debt in the country. Also, if the total amount of loans were repaid to banks, then the broad money supply would shrink. These concepts may be widely misunderstood in the general public, as evidenced by the volume of literature on topics such as "Federal Reserve conspiracy" and "Federal Reserve fraud."

Opinions of the Federal Reserve
The Federal Reserve is lauded by some economists, while being the target of scathing criticism by other economists, legislators, and sometimes members of the general public. The current Chairman of the Federal Reserve Board, Ben Bernanke, is one of the leading academic critics of the Federal Reserve's policies during the Great Depression.

Historic accolades
One of the functions of a central bank is to facilitate the transfer of funds through the economy, and the Federal Reserve System is largely responsible for the efficiency in the banking sector. There have also been specific instances which put the Federal Reserve in the spotlight of public attention. For instance, after the stock market crash in 1987, the actions of the Fed are generally believed to have aided in recovery. Also, the Federal Reserve is credited for easing tensions in the business sector with the reassurances given following the 9/11 terrorist attacks on the United States.

Criticisms
The Federal Reserve is subject to different requirements for transparency and audits than other government agencies, which its supporters claim is another element of the Fed's independence. Although the Federal Reserve has been required by law to publish independently audited financial statements since 1999, the Federal Reserve is not audited in the same way as other government agencies. Some confusion can arise because there are many types of audits, including: investigative or fraud audits; and financial audits, which are audits of accounting statements; there are also compliance, operational, and information system audits.

The Federal Reserve's annual financial statements are audited by an outside auditor. Similar to other government agencies, the Federal Reserve maintains an Office of the Inspector General, whose mandate includes conducting and supervising "independent and objective audits, investigations, inspections, evaluations, and other reviews of Board programs and operations." The Inspector General's audits and reviews are available on the Federal Reserve's website.

The GAO has the power to conduct audits, subject to certain areas of operations that are excluded from GAO audits; other areas may be audited at specific Congressional request, and have included bank supervision, government securities activities, and payment system activities. The GAO is specifically restricted any authority over monetary policy transactions; the New York Times reported in 1989 that "such transactions are now shielded from outside audit, although the Fed influences interest rates through the purchase of hundreds of billions of dollars in Treasury securities;" the law governing the Federal Reserve was subsequently amended (in 1999) to require annual independent audits of the financial statements of the Federal Reserve Banks and the Board.

Congressional oversight on monetary policy operations, foreign transactions, and the FOMC operations is exercised through the requirement for reports and through semi-annual monetary policy hearings. Scholars have conceded that the hearings did not prove an effective means of increasing oversight of the Federal Reserve, perhaps because "Congresspersons prefer to bash an autonomous and secretive Fed for economic misfortune rather than to share the responsibility for that misfortune with a fully accountable Central Bank," although the Federal Reserve has also consistently lobbied to maintain its independence and freedom of operation.

Fulfilment of goals
Another criticism is that exercise of monetary policy in the United States has not achieved consistent success in meeting the goals that have been delegated to the Federal Reserve System by Congress. Goals of Monetary Policy "Sustainable growth, High employment, Stable prices"

Throughout the period of the Federal Reserve's existence, the relative weight given to each of these goals has changed, depending on political developments. In addition, interpretations of how best to implement these goals has also changed substantially, driven by academic developments, research, and the advent of unforeseen economic and financial developments, from the Great Depression to the Second World War and the development of the Bretton Woods system, including abandonment of the Gold Standard in most major Western economies. In particular, the theories of Keynesianism and monetarism have had great influence on both the theory and implementation of monetary policy, and the "prevailing wisdom" or consensus view of the economic and financial communities has changed over the years.


 * 1) High employment - The depression of the late 1920's is generally regarded as being the worst in the country's history, and the Federal Reserve has been criticized for monetary policy which worsened the depression..
 * 2) Stable prices - While some economists would regard any consistent inflation as a sign of unstable prices, policymakers could be satisfied with 1 or 2%; the consensus of "price stability" constituting long-run inflation of 1-2% is, however, a relatively recent development, and a change that has occurred at other central banks throughout the world. Historic inflation has averaged a 3.4% increase annually since the establishment of the Federal Reserve, along with numerous yearly swings of 10% or more.  In contrast, some research indicates that average inflation for the 250 years before the system was near zero percent, though there were likely sharper upward and downward spikes in that timeframe as compared with more recent times.
 * 3) Sustainable growth - The growth of the economy may not be sustainable as the ability for households to save money has been on an overall decline and household debt is consistently rising.

Public confusion
The Federal Reserve has established a library of information on their websites, however, many experts have spoken about the general level of public confusion that still exists on the subject of the economy; this lack of understanding of macroeconomic questions and monetary policy, however, exists in other countries as well. Critics of the Fed widely regard the system as being "opaque," and one of the Fed's most vehement opponents, Congressman Louis T. McFadden, even went so far as to say that "Every effort has been made by the Federal Reserve Board to conceal its powers..." There are, on the other hand, many economists who support the need for an independent central banking authority, and some have established websites that aim to clear up confusion about the economy and the Federal Reserve's operations. The Federal Reserve website itself publishes various information and instructional materials for a variety of audiences.

Criticism by Libertarians and the Austrian school
Some economists, especially those belonging to the heterodox Austrian School criticize the idea of even establishing monetary policy, believing that it distorts investment. According to Austrian economics, without government intervention, interest rates will always be an equilibrium between the time-preferences of borrowers and savers, and this equilibrium is simply distorted by government intervention. This distortion, in their view, is the cause of the business cycle.