Statistics: What the Federal Reserve Monetary Policy Signals
Updated 2/13/20, Posted 10/14/13
By Jean Regan, President & CEO
In this seven part series, I’m focusing on different commonly referenced indicators and explaining their impact. These indicators are (1) the unemployment rate, (2) the inflation rate, (3) housing sales and starts, (4) the Federal Reserve’s Monetary Policy, (5) retail sales, (6) ISM non-manufacturing and manufacturing index, and (7) GDP growth.
The Federal Reserve Act was passed into law in 1913 by President Woodrow Wilson. In the time that it has been in existence, the monetary policies created by the Federal Reserve have greatly influenced the economy, particularly during times of recession or depression. Since these policies have such a large impact, they’re something that everyone should understand and pay attention to, especially when making plans for the year ahead.
What is the Federal Reserve Monetary Policy?
The Federal Reserve Monetary Policy is the collection of the policies created in order to influence the availability and cost of money and credit.
There are three tools of monetary policy that the Fed controls: (1) open market operations, (2) the discount rate, and (3) reserve requirements. In a nutshell, open market operations are the purchase and sale of securities in the open market by a central bank. The discount rate is the interest rate that is charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility. Last but not least, reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. These requirements range from 0-10 percent of their net accounts depending on the total balance.
Who Makes up the Federal Reserve Board of Governors?
Monetary policy tools use is determined by the seven member Federal Reserve System Board of Governors, which is responsible for the discount rate and reserve requirements, and the twelve member Federal Open Market Committee (FOMC), which is responsible for open market operations.
The FOMC has eight regularly scheduled meetings during the year and holds additional meetings as needed. After each meeting, a statement is released which describes their decisions and the rationale behind them – this is something to watch for since it plays a pivotal part in determining where the economy is headed.
What does the Federal Reserve Monetary Policy mean for the economy?
The policy that the Federal Reserve makes is intended to stabilize the economy and promote growth. It specifically looks for signs of a sound economy, such as maximum employment (6-1/2 percent or less), price stability, inflation of about 2 percent and GDP growth.
One way the Federal Reserve influences the economy is by altering the federal funds rate. Changes in the federal funds rate can trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and a range of other economic variables, including employment, output, and the prices of goods and services.
Lending to financial institutions is another important way that the Federal Reserve can impact the economy. We saw this happen in 2008. When financial institutions such as Washington Mutual, Lehman Brothers, and Bear Stearns folded, the Federal Reserve provided loans to JP Morgan Chase, AIG and others in order to prevent a domino effect leading to the collapse of other financial institutions. As you may recall, this lending was no small token and peaked at $1.5 trillion in December of 2008.
If you’re still wondering why that happened, imagine this scenario: you start a small lending institution with $100, loan the entire amount out, and expect to have $5 a week returned in order to sustain operations. After waiting one week, then two weeks, and then three weeks, none of the money is being paid back. Now you find yourself unable to pay your own electricity bill or other bills arriving. The electricity company in turn may not be able to pay their vendors and the chain continues. On a small scale, this is part of what was happening around the country as we entered the most recent recession. The loans provided by the Federal Reserve allowed businesses to have the income they need to continue operations.
What about quantitative easing?
Yet another way the Federal Reserve influences the economy is through its purchases. In 2008 they made an unprecedented purchase of securities and mortgage agency longer-term debt. How much? To support the housing market they purchased $1.25 trillion in mortgage-backed securities guaranteed by agencies such as Freddie Mac and Fannie Mae and about $175 billion of mortgage agency longer-term debt. They also purchased $300 billion in longer-term Treasury securities.
While the Federal Reserve may take actions to promote growth or mitigate a recession, as Chairman Ben Bernanke once warned, “Monetary policy is not a panacea.” The overall impact of its policies depends on other factors taking place in the economy.
What does the Federal Reserve Monetary Policy mean for the logistics industry?
For one, monetary policy impacts which investments businesses make. By choosing how much money to produce, the Fed determines the cost to borrow money, which in turn influences the cost to makes business investments. When businesses are able to invest more, it typically leads to increased economic activity including increased shipment of goods.
Monetary policy also impacts how inventory is treated. The carrying cost of inventory is largely influenced by the cost of borrowing money. As such, many businesses will benefit from lean operations where they carry less inventory, but this is not always in practice. A rise in the cost of borrowing money would likely motivate those who are still holding inventory and not yet operating lean to move goods faster, which would in turn increase their transportation needs.
It’s difficult to say how the Federal Reserve will impact the economy in the coming years. What’s almost certain, though, is that it will be beneficial to pay attention to their actions in order to develop the best plans for a business and to anticipate what will happen in the logistics industry.
How have you seen the Federal Reserve Monetary Policy influence the logistics industry? Are there any tools you use to keep an eye on policy changes? Comment below to share.