Interest Rate Determination

Controlling the Money Supply

Learning Objective

1. Learn the mechanisms (or tools) the U.S. Federal Reserve Bank can use to control the U.S. money supply.

The size of the money stock in a country is primarily controlled by its central bank. In the United States, the central bank is the Federal Reserve Bank while the main group affecting the money supply is the Federal Open Market Committee (FOMC). This committee meets approximately every six weeks and is the body that determines monetary policy. There are twelve voting members, including the seven members of the Fed Board of Governors and five presidents drawn from the twelve Federal Reserve banks on a rotating basis. The current Chairman of the Board of Governors is Ben Bernanke (as of January 2010). Because Bernanke heads the group that controls the money supply of the largest economy in the world, and because the FOMC's actions can have immediate and dramatic effects on interest rates and hence the overall United States and international economic condition, he is perhaps the most economically influential person in the world today. As you'll read later, because of his importance, anything he says in public can have tremendous repercussions throughout the international marketplace.

The Fed has three main levers that can be applied to affect the money supply within the economy: (1) open market operations, (2) reserve requirement changes, and (3) changes in the discount rate.