chAPTER ThiRTEEn • DomEsTic AnD Economic Policy 313
Federal Open
Market Committee
The most important body
within the Federal Reserve
System. The Federal Open
Market Committee decides
how monetary policy
should be carried out.checks from one bank to another. In addition, it holds reserves deposited by most of the
nation’s banks, savings and loan associations, savings banks, and credit unions. Finally, it
plays a role in supervising the banking industry.organization of the Federal Reserve system. A board of governors manages the
Fed. This board consists of seven full-time members appointed by the president with the
approval of the Senate. There are twelve Federal Reserve district banks. The most impor-
tant unit within the Fed is the Federal Open market committee. This is the body that
actually determines the future growth of the money supply and other important economy-
wide financial variables. This committee is composed of the members of the Board of
Governors, the president of the New York Federal Reserve Bank, and presidents of four
other Federal Reserve banks, rotated periodically.
The Board of Governors of the Federal Reserve System is independent. The president can
attempt to influence the board, and Congress can threaten to merge the Fed into the Treasury
Department, but as long as the Fed retains its independence, its chairperson and gover-
nors can do what they please. Hence, any talk about “the president’s monetary policy” or
“Congress’s monetary policy” is inaccurate. The Fed remains a relatively independent entity.loose and Tight monetary Policies. The Federal Reserve System seeks to stabilize
nationwide economic activity by controlling the amount of money in circulation. Changing
the amount of money in circulation is a major aspect of monetary policy. You may have
read a news report in which a business executive complained that money is “too
tight.” You may have run across a story about an economist who has warned that
money is “too loose.” In these instances, the terms tight and loose refer to the
monetary policy of the Fed.
Credit, like any good or service, has a cost. The cost of borrowing—the interest
rate—is similar to the cost of any other aspect of doing business. When the cost of
borrowing falls, businesspersons can undertake more investment projects. When it rises,
business persons undertake fewer projects. Consumers also react to interest rates when
deciding whether to borrow funds to buy houses, cars, or other “big-ticket” items.
If the Fed implements a loose monetary policy (often called an “expansion-
ary” policy), the supply of credit increases and its cost falls. If the Fed imple-
ments a tight monetary policy (often called a “contractionary” policy),
the supply of credit falls (or fails to grow) and its cost increases. A loose
money policy is often implemented as an attempt to encourage eco-
nomic growth. You may be wondering why any nation would want
a tight monetary policy. The answer is to control inflation. If money
becomes too plentiful too quickly, prices on average increase, and the
purchasing power of the dollar decreases.Time lags for monetary Policy. You learned earlier that policymak-
ers who implement fiscal policy—the manipulation of budget deficits
and the tax system—experience problems with time lags. Similar prob-
lems face the Fed when it implements monetary policy.
Sometimes, accurate information about the economy is not available
for months. Once the state of the economy is known, time may elapse
before any policy can be put into effect. Still, the time lag in implementing
monetary policy is usually much shorter than the lag in implementing fis-
cal policy. The Federal Open Market Committee meets eight times a year
and can put a policy into effect relatively quickly. A change in the money
supply may not have an effect for several months, however.Benjamin s. Bernanke
was the chair of the Board of Governors
of the Federal Reserve System through
January 2014. Some commentators
contend that the chair of the Fed is the
most powerful person on earth, at least in
terms of economics. Since the start of the
Great Recession, the “Fed” has engaged
in activities aimed at fighting recession
that it has never engaged in before.
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