According to Fred Weston and Eugene Brigham in their book Essentials of Managerial Finance, monetary policy involves the regulation of the money supply and of interest rates by a central bank. In the United States, monetary policy is determined by the U.S. central bank called the Federal Reserve Board. The goals of the Federal Reserve Board (the Fed) are to encourage economic growth, control inflation, reduce unemployment to acceptable levels and stabilize the exchange rate between the U.S. dollar and foreign currencies in the foreign exchange marketplace. Monetary policy is one the two ways the government can impact the economy. By regulating the cost of money, the Federal Reserve can affect the amount of money that is spent by consumers and businesses (Weston & Brigham 97).
Wayne Angell writing in the Federal Reserve Bulletin explains that the discount rate is the interest rate charged by the Federal Reserve when banks borrow overnight from the Fed. The discount rate is under the direct control of the Fed. The Federal Funds Rate is the interest rate charged by banks when banks borrow from each other. The funds rate fluctuates according to supply and demand but is not under the direct control of the Fed, but is strongly influenced by the Fed's actions. The Fed adjusts the funds rate using open market operations. The Fed sells U.S. treasury securities to banks. Therefore, banks' reserves at the Fed drop, and because banks have to maintain a specific level of reserves, banks must borrow from each other to cover their short position at the Fed. The resulting pressure on intra-bank lending funds pushes fund rates and interest rates up. The Fed can lower interest rates by lowering the required reserves or by lowering the discount rate (Angell 1132).
Alan Greenspan in Federal Reserve Bulletin suggests that the role of Federal Reserve Bank involves three basic duties. First and foremost, the Federal Reser
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