monetary and fiscal policies

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The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals. The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy.

The Federal Reserve controls the three tools of monetary policy--open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate.
The Federal Reserve System is a quasi-governmental banking system. Its composition is as follows:
(1) Presidentially-appointed Board of Governors of the Federal Reserve System in Washington, D.C.
(2) The Federal Open Market Committee;
(3) 12 regional Federal Reserve Banks located in major cities throughout the nation; and (4) numerous private member banks, which own varying amounts of stock in the regional
Federal Reserve Banks.

(Wikipedia)

The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.

Changes in the federal funds rate 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, ultimately, a range of economic variables, including employment, output, and prices of goods and services.

The central bank influences interest rates by expanding or contracting base money, which consists of currency in circulation and banks' reserves on deposit at the central bank. The primary ways that the central bank can affect base money is by open market operations or sales and purchases of second hand government debt, or by changing the reserve requirements. If the central bank wishes to lower interest rates, it purchases government debt, thereby increasing the amount of cash in circulation or crediting banks' reserve accounts. Alternatively, it can lower the interest rate on discounts or overdrafts (basically loans to banks secured by suitable collateral, specified by the central bank). If the interest rate on such transactions is sufficiently low, commercial banks can borrow from the central bank to meet reserve requirements and use the additional liquidity to expand their balance sheets, increasing the credit available to the economy. Lowering reserve requirements has a similar effect, freeing up funds for banks to increase loans or buy other profitable assets.

Monetary policy can be implemented by changing the size of the monetary base. This directly changes the total amount of money circulating in the economy. In the United States, the Federal Reserve can use open market operations to change the monetary base. The Federal Reserve would buy/sell bonds in exchange for hard currency. When the Federal Reserve disburses/collects this hard currency payment, it alters the amount of currency in the economy, thus altering the monetary base. Note that open market operations are a relatively small part of the total volume in the bond market, thus the Federal Reserve is not able to influence interest rates through this method.

Reserve Requirements

The monetary authority exerts regulatory control over banks. Monetary policy can be implemented by changing the proportion of total assets that banks must hold in reserve. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortages and loans. By changing the proportion of total assets to be held as liquid ...