Monetary Policy And The Stock Exchange

4 Pages 982 Words

In an effort to try and manage the economy, the Federal Reserve has traditionally conducted open market operations through the purchase and sale of government bonds. Open market operations involve the buying and selling of U.S. government securities. The term "open market" means that the Fed doesn’t decide on its own which securities dealers it will do business with on a particular day. Rather, the choice emerges from an "open market" in which the various securities dealers that the Fed does business with—the primary dealers—compete on the basis of price. The object of monetary policy is to influence the performance of the economy as reflected in such factors as inflation, economic output, and employment. It works by affecting demand across the economy—that is, people's and firms' willingness to spend on goods and services. Open market operations are flexible and thus, the most frequently used tool of monetary policy. In principle, the Fed could conduct monetary policy through the purchase and sale of stocks on the New York Stock Exchange. There are however, major drawbacks to such a policy.
First of all, the Fed chooses to have government bonds issued from the treasury in order to borrow money for the purpose of paying back deficit spending. This way, the government has some control over the number of bonds that are issued. The money is borrowed from the ones who purchase the bonds. Thus it is the purchasers of the bonds who guarantee that the bonds will be paid back. The government promises to back the bonds based on future tax receipts making bonds a solid asset. So when the Fed buys and sells bonds, security is already in place by future tax payers. This process makes United States government bonds a “riskless” venture.
The process of buying and selling U.S. Bonds is a smooth way of helping everyone. No one holds a gun to someone’s head and forces them to buy bonds—no one compels to lend and no one compels to b...