How the Fed Changes Interest Rates

Monetary policy involves refers to actions taken by the federal reserve to manage the amount of money and credit in the monetary system.  He begins with an explanation of fiat monetary systems to provide a basis for this discussion.

Fiat money is currency that is not backed by any commodity, rather it is backed by the credit of a government or entity.  Fiat money derives its value from its relative availability and confidence from its holders.  This is important to understand since the Federal reserve can significantly affect the value of the currency through a variety of approaches; open market operations, raising or lowering the discount rate, and raising or lowering reserve requirements.  This video focuses on the Fed's open market operations. 

Through its open market operations, the Fed can increase or decrease the money supply by buying or selling government securities.  When they buy government securities this will increase the money supply in the market and decrease interest rates.  Conversely, to increase interest rates, the fed will sell government securities to take dollars out of circulation which decrease the money supply.


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