The Federal Reserve: monetary vs. fiscal policy, open-market operations, and the discount and federal funds rates

Who controls which policy?

The Federal Reserve conducts monetary policy, influencing money, credit, and interest rates. Its statutory goals are maximum employment, stable prices, and moderate long-term interest rates. Fiscal policy is the federal government's use of taxation and spending, carried out by Congress and the President. A tax cut is fiscal policy; a change in the Federal Reserve's interest-rate target is monetary policy.

Buying and selling securities

The Federal Open Market Committee, or FOMC, directs the Federal Reserve's open-market operations. These are purchases and sales of securities in the market. A Fed purchase pays money into the banking system and adds reserves. In the basic easing framework, that supports credit availability and downward pressure on short-term rates. A Fed sale takes payment out of the banking system and drains reserves, fitting a tightening framework.

Think from the Fed's side: buying adds reserves; selling removes reserves. These describe policy mechanisms and intended pressures, not guaranteed economic outcomes; modern implementation also uses administered rates, and the effect of reserve changes depends on conditions.

Two rates, two lenders

The federal funds rate is the rate banks charge each other for overnight borrowing of reserve balances. The FOMC sets a target range for that rate; it does not dictate the rate on each individual loan. The effective federal funds rate reflects market transactions.

The discount rate is charged by the Federal Reserve on loans to banks through the discount window. Separate the two by identifying the lender: bank to bank means federal funds; Federal Reserve to bank means discount. Neither is the prime rate, which banks quote to their most creditworthy business customers.

Easing, tightening, and securities credit

Easing seeks to support borrowing and economic activity, commonly through a lower federal funds target. Tightening seeks to restrain demand and inflation pressure, commonly through a higher target. Higher market yields generally reduce prices of existing fixed-rate bonds; lower yields generally raise them.

The Federal Reserve Board also has authority to regulate credit used to purchase or carry securities, including margin requirements. Margin concerns securities financing; fiscal policy concerns taxes and spending. For exam questions, first identify the actor, then the tool, then the intended direction of its effect.