Macroeconomic Impact on Business Operations

There are three main tools the Federal Reserve can utilize to control the US money supply. These three major tools are: reserve requirements, discount rate, and open market operations. The US economy, which is influenced by national interest rates, inflation variability, and unemployment rates, these areas also have an effect on the overall economic growth of the country, are all significantly influenced by the monetary policies in operation by the Federal Reserve. In addition to these factors influenced by the Federal Reserve, the Central Bank can also offset and influence the US economy with the process of money creation. This paper will identify and analyze the tools used by the Federal Reserve to control monetary policy, and how this, in turn influences the US economy and money supply.

The first of the three major tools employed by the Federal Reserve is known as reserve requirements. Reserve requirements can be defined as: “The ratio of reserves (vault cash plus deposits at a Fed bank) to transactions deposits that commercial banks must keep on hand.” (Dakota State University, 2003) These reserves are held for specified deposit liabilities by federally insured banking institutions. Reserve limitations are specified by law, and under the sole authority of the Board of Governors. (The Federal Reserve Board [FRB], 2006) While the Board of Governors has sole authority over the reserve requirements, manipulation to this policy is fairly infrequent, once every 5 to 10 years on average. (Johnson, 2005, para. 13)

The second tool used by the Federal Reserve to control money supply is known as the discount rate (DR).

The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility… Discount rates are established by each Reserve Bank's board of directors, subject to the review and determination