The Federal Reserve System and Monetary Policy

Topic: Banking
Words: 1180 Pages: 4

Are credit cards or debit cards money?

Credit cards and debit cards are not considered as a form of money. Money is defined as a medium of exchange, which represents an asset given in place of goods and services between two or more parties. Money is regarded as an asset that is obtained by converted other assets, which are regarded as accepted in business transactions. Currency, as well as demand deposits, are considered money, but credit cards and debit cards are not owned by the holder hence not regarded money (DePersio, 2021). Credit cards and debit cards are means of payment because they are an acceptable arrangement that enables the transfer of money from one party to another. Credit cards and debit can be regarded as plastic money that facilitate transactions instead of carryng cash but they are not regarded as a medium of exchange (“5 Stages of Evolution of Money,” 2014) Medium of exchange refers to what is paid while means of payment refers to how the payment is facilitated.

Credit cards are given by the bank or a financial institution to be used to pay off loans that attract interest. When using a credit card, money from banks is paid to the seller, hence, the credit card enables the transfer of funds from the bank to the seller (DePersio, 2021). The interest is determined by the bank that has issued the card, and the cardholder must consent to pay the amount borrowed plus the interest. When using a debit card, money is deducted directly from one’s bank account, and no interest is required, although the process may be subject to a service fee. All these functions of debit cards and credit cards describe them as means of payment as opposed to money which is a medium of exchange.

When the Fed makes an open market purchase of government securities, the quantity of money will eventually decrease by a fraction of the initial change in the monetary base.” Is the previous statement correct or incorrect?

The statement is not right because the supply of money increases when Fed buy government securities. The open Reserve makes purchases of government securities to regulate the money supply and level of interest. This influences the willingness and ability of banks to lend, as well as the willingness of businesses to borrow and make investments. The Federal Open Market Committee (FOMC) creates policies to aim to create employment opportunities and regulate inflation. The policies are meant to either reduce or increase the money supply by increasing the interest rates of loans given by financial institutions.

When the Fed trading desk purchases bonds from banks or any other financial institutions, it deposits the payment on bank accounts of the buyers. This increases the money available for banks and other financial institutions, hence encouraging the banks to offer loans at lower interest rates. Low-interest rate offers suitable conditions for increased borrowing and investment to stimulate the economy and create employment opportunities (Amadeo, 2021). This improves people’s spending and business transactions which translated to increased Gross Domestic Product (GDP). On the other hand, the fed trading department can sell securities to reduce inflation by limiting the money supply. This will lead to increased interest rates and less borrowing capacity.

Monetary policy is action taken by the Fed to influence the level of real GDP. Suppose the Fed wants to increase the money supply. What three tools could the Fed use to achieve this goal?

Monetary policies act as tools for expanding or constricting the economy depending on the prevailing condition of a country’s gross domestic product. An expansionary policy aims at accelerating economic growth by creating job opportunities, especially in ties of recessions. This occurs through the reduction of interest rates to lure businesses to borrow money in order to pursue expansion. Conventionally, Fed utilizes three monetary policy techniques of controlling money supply, including reserve requirements adjustment, buying and selling in the open market, and the discount rate (Amadeo, 2021). However, another policy of paying interest on reserve balance was added to the Fed’s monetary policy toolkit in 2008. Recently, overnight reverse repurchase agreements are also recognized as a monetary policy tool.

The Federal Reserve Act enacted in 1913 required financial institutions to set aside a certain proportion of their deposit as cash on hand or reserve bank deposits as reserves. The act authorized Fed to set a specific percentage of reserves according to the deposits amounts available for saving banks, commercial banks, and even foreign financial institutions. Currently, the reserve is set at 10% for financial institutions with liabilities over $58.8 million (Amadeo, 2021). When Fed reduces reserve requirements, banks are left with a higher ability to lend, hence improving the money in circulation and the economy. When the discount rate increases, bank reserves within the banking system reduces leading decrease in amount of money in circulation. Increasing discount rates discourages borrowing from the reserve banks, which reduces their reserves and lending capability (Amadeo, 2021). This can indirectly result in increased loan interests, which discourages borrowing and investments. Generally, Fed action on raising discount rate leads to an increase in interest rates of other financial institutions with an aim of reducing inflation.

Open market operations by the Federal Reserve help increase the money supply through the purchase of treasury securities. Buying of treasuries securities, such as treasury bonds, can be termed as expansion monetary policy because it eases borrowing and investment. When the Fed intends to heighten money supply, it buys Treasury bonds which are deposited with banks. These deposits increase the strength of the bank to give loans to its customers. The injection of reserves to financial institutions reduces interest rates as the banks have large amounts of deposits which can be given as loans to customers. On the contrary, when the Fed sells its government securities, buyers use withdrawal money from their banks to pay (Board of Governors of the Federal Reserve System, n.d.). Since the banks have less amounts in their reserves for lending, loans become expensive through the increment of the interest rate. When interest rates are high, borrowing and investments also reduce as people are not willing to pay loans at expensive and high-interest rates.

An example of the monetary policy of open market operations was witnessed in the post-recession economy. During the financial crisis, the federal fund target was reduced to a figure near zero, and the government had to use other methods to increase liquidity and stimulate recovery. The Fed purchased a large amount of treasury securities and mortgage-related securities through open market operations (Amadeo, 2016). The purchases were paid by adding reserve deposits to banks resulting in large quantities of reserves deposits exceeding the legal requirements. In this case, the Fed can use the interest on excess reserves method and change the interest rate over time. Monetary policies can impact the demand and volume of exports due to increases or reductions in business activities or transactions (Amadeo, 2016). However, it is always recommendable to keep the applied monetary tools in check to ensure the economy is regulated appropriately.


5 stages of evolution of money. Your Article Library. (2014).

Amadeo, K. (2016). The Fed’s tools and how they work. The Balance.

Amadeo, K. (2021). Four tools central banks use to control the world economy. The Balance.

Board of Governors of the Federal Reserve System. (n.d.). Policy tools. 

DePersio, G. (2021). Debit card vs. credit card: what’s the difference? Investopedia.

Checking Accounts and Credit Cards
Federal Reserve and Monetary Policy of USA