Federal Open Market Committee and U.S. Monetary Policy
This paper examines how the Federal Open Market Committee determines monetary policy in the United States and analyzes key macroeconomic indicators as of mid-2014. The paper explains the three primary mechanisms through which the Federal Reserve influences money supply—open market operations, discount rate setting, and reserve requirements—and evaluates their effects on inflation and employment. The analysis includes detailed assessment of U.S. GDP growth, employment trends, consumer price index changes, and manufacturing orders, alongside comparative economic conditions in Europe and Japan. Based on Taylor principle analysis, the paper evaluates the FOMC's decision to maintain the federal funds rate at 0–0.25 percent in the context of economic data.
- How the Federal Open Market Committee Determines Monetary Policy: FOMC mechanisms for controlling money supply and interest rates
- Analysis of U.S. Gross Domestic Product: GDP growth trends and components in 2014
- Analysis of U.S. Employment: Unemployment rates and job creation data
- Consumer Price Index and Inflation Trends: CPI changes and inflation measurement methods
- Durable Goods Orders and Capital Investment: Manufacturing orders and business investment patterns
- Economic Conditions in Europe and Japan: International GDP, employment, and inflation comparison
- Monetary Policy Recommendations: Policy evaluation using Taylor principle framework
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What makes this paper effective
- Comprehensive breakdown of FOMC's three primary policy tools (open market operations, discount rates, reserve requirements) with clear explanations of mechanism and impact
- Systematic analysis of multiple macroeconomic indicators—GDP, employment, CPI, durable goods orders—providing concrete data to support policy assessment
- Comparative international context by examining economic conditions in Europe and Japan, strengthening the paper's analytical scope
- Evidence-based conclusion using Taylor principle to evaluate actual FOMC decisions against economic conditions
Key academic technique demonstrated
The paper employs data-driven policy analysis: rather than discussing monetary policy theory in isolation, it anchors each explanation to specific economic statistics from 2014. This grounds abstract concepts (like reserve requirements) in measurable outcomes (unemployment, inflation rates, GDP components). The final recommendation section applies Taylor principle—a quantitative policy framework—to validate the FOMC's actual decisions, demonstrating how academic theory informs real-world central banking.
Structure breakdown
The paper follows a standard macroeconomic analysis structure: it first explains the policy mechanism (how FOMC operates), then presents empirical evidence across five indicator categories (GDP, employment, CPI, durable goods, international comparison), and concludes with policy evaluation. This inductive approach—mechanism, then evidence, then recommendation—allows readers to understand both the "how" and "why" of monetary policy before assessing its appropriateness.
How the Federal Open Market Committee Determines Monetary Policy
Monetary policy consists of the actions taken by a central bank to change the supply of money and interest rates, thereby affecting economic activity. In the United States, the Federal Reserve establishes monetary policy. It works to ensure that the money supply grows neither too quickly—which would cause excessive inflation—nor too slowly, which would hamper economic growth. The Federal Reserve aims for an ideal inflation rate of 2 percent to 3 percent annually to keep prices stable. Additionally, the Fed seeks to maintain unemployment at approximately 5 percent.
The Federal Reserve influences money supply through three primary mechanisms:
Buying and selling U.S. treasuries through open market operations: When the Federal Open Market Committee buys treasuries from security dealers in the market, it increases the money supply and lowers interest rates. Conversely, selling treasuries to security dealers removes money from circulation, decreasing the money supply and raising interest rates.
Setting the discount rate: The Federal Reserve establishes the interest rate that banks with excellent credit ratings pay on overnight loans from the Federal Reserve Bank, known as the discount rate. Banks with lower credit ratings must borrow at higher rates. The Federal Reserve Board of Governors oversees this function.
Establishing reserve requirements: The Federal Reserve requires banks to hold a certain percentage of deposits on hand—for example, 10 percent—to meet customer withdrawals. Banks lend out or invest the remaining 90 percent to earn income. Banks deposit any excess funds with their district Federal Reserve Bank, making those funds available for other banks to borrow at a discount rate to maintain their reserve requirements.
The level of bank reserves affects the short-term interest rates that banks charge each other for overnight borrowing and lending, which helps banks maintain required reserve levels. These reserve levels subsequently affect the interest rates that banks charge consumers for products like car loans and mortgages, and they influence the overall inflation rate in the economy.
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