| It's the Federal Reserve Bank that influences the | | | | with regard to how slowly the economy is growing |
| money supply. Three tools are used to implement | | | | and the rate of inflation, before determining monetary |
| monetary policy: | | | | policy. |
| 1. Open Market Operations | | | | The bond market plays close attention to the activities |
| 2. Discount Rates | | | | of the Federal Reserve, which is why it’s important |
| 3. Reserve Requirements | | | | for us as well. |
| Since open market operations is the tool used most, | | | | The Federal Reserve has three goals: |
| we will cover it. Here's how it works: When the | | | | 1. Moderate economic growth (not too fast, not too |
| economy is growing too fast and the Fed is worried | | | | slow) |
| about the inflation rate, it will sell government securities | | | | 2. Low unemployment |
| from its portfolio to the open market. This decreases | | | | 3. Low inflation |
| bank reserves, which means the money supply | | | | How does the Fed determine whether they are |
| decreases. When there are less bank and businesses | | | | reaching these goals? They watch the same |
| have to pay the bank more in order to borrow. This | | | | economic indicators as we do. In other words, they |
| discourages consumers and businesses from | | | | monitor the reports that are released by the Labor |
| borrowing. Less borrowing means less spending, which | | | | Department, the segments of our economy. |
| slows the economy and eventually can reduce price | | | | For instance, the Gross Domestic Product (GDP) |
| pressures. | | | | consists of four major components: (1) consumption; (2) |
| When the economy is growing too slowly and the | | | | investment; (3) government; (4) exports. Most of the |
| inflation rate is low the Fed will buy government | | | | key economic indicators fall into one of the above |
| securities, such as Treasury bills and notes. This | | | | categories. For example: |
| increases bank reserves, which increases the money | | | | - Retail sales would fall under consumption. |
| supply and causes short-term interest rates to | | | | - Business inventories and housing starts would fall |
| decrease. Reduced rates induce consumers and | | | | under investment. |
| businesses to borrow. Consumers will borrow money | | | | - Construction Spending would fall under government. |
| for items such as automobiles or home loans. | | | | - Trade would fall under exports. |
| Businesses borrow to build their inventories or finance | | | | If the key economic indicators continue to come in |
| a new factory. As a result, economic growth will | | | | strong, the GDP will increase. If the indicators come in |
| accelerate. | | | | weak, it will decrease. In other words, Gross Domestic |
| The Fed will also leave rates unchanged if the | | | | Product measures economic growth. |
| economy is growing at a moderate pace with low | | | | Learn more about the Bond Market, sign up for Paul |
| inflation or if they feel the economy will slow down by | | | | Judd's Free BondLessons, click here. |
| itself. They will even take a wait-and-see approach | | | | |