Monetary policy:

Monetary policy is one of the tools that a Government uses to along with fiscal policy to influence its economy. Using its monetary authority to control the supply and availability of money, a government attempts to influence the overall level of economic activity in line with its political objectives. Usually this goal is "macroeconomic stability" - low unemployment, low inflation, economic growth, and a balance of external payments. Monetary policy is usually administered by a Government appointed "Central Bank".

The tools of Monetary Policy are:

Open Market Operations: Open market operations are the most important and active tool of monetary policy that the Fed uses. These operations consist of the Fed buying and selling previously issued U.S. government securities, or IOUs of the federal government. The Fed adds extra credit to the banking system when it buys Treasury securities from the dealers, and drains credit when it sells to the dealers. As the laws of supply and demand take over in the reserves market, the cost of funds for the remaining reserves finds its level at the federal funds rate. The federal funds rate is the interest rate banks charge each other for overnight loans.

Discount Rate: Discount rate, another tool of monetary policy, is the interest rate that the Fed charges banks for short-term loans. Changes in the discount rate typically occur in conjunction with changes in the federal funds rate.Through the discount window, Federal Reserve Banks lend funds to depository institutions.

Reserve Requirements: Reserve requirements are the percentages of certain types of deposits that banks must keep on hand in their own vaults or on deposit at a Federal Reserve Bank. The Fed has the authority to set reserve requirements on checking accounts and certain types of savings accounts.

Changes in the reserve requirement make planning difficult for lenders, and any increase imposes a cost on them. The Fed generally does not change the reserve requirement when there is an alternative way of achieving the same policy result.