Monetary Policy

Monetary Policy and the Effect on Macroeconomic Factors

“Simplistically, it looks like the Fed tries to use money supply as a lever to keep the economy on the rail.” Monetary Policy Simulation University of Phoenix, 2007.

Yet monetary policy is only effective with the creation of money. Banks create money through lending. An early “embryonic banker” (McConnell & Brue, 2004, P253), the goldsmith, was the impetus for the creation of the first reserve system which initiated the creation of paper money. The goldsmith had to denote the amount of reserve essential for insurance before generating the paper money. As the newly created reserve system grew, the natural tendency to bank panics led to the need for regulations. The banking systems’ ability to create money rests on the assumption that commercial banks are willing to create money by lending and that households and businesses are willing to borrow. The process is cyclical and creates the need for some kind of control.

Monetary policy is made by the Federal Open Market Committee, which consists of the Board of Governors of the Federal Reserve System and the