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Federal Reserve‘s Role in US Monetary Policy and the Dollar
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The Federal Reserve (Fed) is the entity responsible for shaping monetary policy in the United States. Its operational framework is guided by two primary objectives: maintaining price stability and promoting full employment. The Fed’s principal instrument for achieving these goals involves the strategic adjustment of interest rates. When inflation escalates beyond the Fed’s target of 2%,leading to rapid price increases,the Fed responds by raising interest rates. This action increases the cost of borrowing across the economy, which in turn tends to strengthen the US Dollar (USD). A higher interest rate environment makes the United States a more appealing destination for international investors seeking returns on their capital. Conversely, if inflation falls below the 2% threshold or if the unemployment rate is elevated, the Fed may opt to lower interest rates. This policy aims to stimulate borrowing and economic activity, which typically exerts downward pressure on the US Dollar.
The Federal Reserve convenes eight scheduled policy meetings annually. During these sessions, the Federal Open Market Committee (FOMC) convenes to evaluate prevailing economic conditions and to formulate monetary policy decisions. The FOMC comprises twelve Federal Reserve officials. This group includes the seven members of the Board of Governors,the president of the Federal Reserve Bank of New York,and four presidents from the remaining eleven regional reserve Banks. These four regional presidents serve one-year terms on a rotational basis.
In exceptional circumstances, the Federal Reserve may implement a policy known as Quantitative Easing (QE). QE is a process designed to significantly increase the availability of credit within a struggling financial system. This non-standard policy measure is typically employed during periods of financial crisis or when inflation rates are exceptionally low. The Fed utilized QE as a primary tool during the Great Financial Crisis of 2008. The mechanism involves the Fed creating new US Dollars and using these funds to purchase high-quality bonds from financial institutions. Generally, QE tends to weaken the US Dollar.
Quantitative Tightening (QT) represents the inverse of Quantitative Easing
