Congress has delegated responsibility for monetary policy to the Fed, but retains oversight responsibilities to ensure that the Fed is adhering to its statutory mandate of "maximum employment, stable prices, and moderate long-term interest rates." The Fed has defined stable prices as a longer-run goal of 2% inflation—the change in overall prices, as measured by the Personal Consumption Expenditures (PCE) price index. Monetary policy can be used to stabilize business cycle fluctuations (alternating periods of economic expansions and recessions) in the short run, while it mainly affects inflation in the long run. Recent Monetary Policy Developments

In December 2008, in the midst of the financial crisis and the "Great Recession," the Fed lowered the federal funds rate to a range of 0% to 0.25%. As a result, the economic expansion was in its seventh year and the unemployment rate was already near the Fed's estimate of full employment when it began raising rates on December 16, 2015. The Fed raised rates once in 2016, three times in 2017, and four times in 2018, by 0.25 percentage points each time. Although monetary policy is now less stimulative than it had been at the zero lower bound, the Fed is still adding stimulus to the economy as long as the federal funds rate is below what economists call the "neutral rate" (or the long-run equilibrium rate). The unemployment rate has been below 5% since 2015 and is now lower than the rate believed to be consistent with full employment. Despite strong economic data (which is only available with a lag), the Fed announced in January 2019 that it would be "patient" before raising rates again in light of increased economic uncertainty and financial volatility. Some critics would prefer clear evidence that inflation is above the Fed's target or financial conditions are unstable before the Fed raises rates again. The Fed has responded to this literature and is increasingly transparent in explaining its policy measures and what these measures are expected to accomplish. Targeting Interest Rates Versus Targeting the Money Supply

The Fed's control over monetary policy stems from its exclusive ability to alter the money supply and credit conditions more broadly. The Fed conducts monetary policy by focusing on the cost of money and credit as proxied by the federal funds rate. To reduce spending in the economy, the Fed raises interest rates and the process works in reverse. Foreign capital outflows would reduce the trade deficit through an increase in spending on exports and domestically produced import substitutes. When interest rates become extremely low, interest-sensitive spending may no longer be very responsive to further rate cuts. But because of the Fed's independence from Congress and the Administration, the two policy options are not always coordinated. Beginning on September 18, 2007, and ending on December 16, 2008, the federal funds target was reduced from 5.25% to a range between 0% and 0.25%, where it remained until December 2015. The decision to maintain a target interest rate near zero was unprecedented. To circumvent this problem, the Fed decided to use nontraditional methods to provide additional monetary policy stimulus. From the introduction of its first emergency lending facility in December 2007 to the worsening of the crisis in September 2008, the Fed sterilized the effects of lending on its balance sheet (i.e., prevented the balance sheet from growing) by selling an offsetting amount of Treasury securities. Quantitative Easing and the Growth in the Fed's Balance Sheet and Bank Reserves

With short-term rates constrained by the zero bound, the Fed hoped to reduce long-term rates through large-scale asset purchases, which were popularly referred to as quantitative easing (QE). Between 2009 and 2014, the Fed undertook three rounds of QE, buying U.S. Treasury securities, agency debt, and agency mortgage-backed securities (MBS). The hope is that a reduction in those rates feeds through to private borrowing rates throughout the economy, stimulating spending on interest-sensitive consumer durables, housing, and business investment in plant and equipment. The "Exit Strategy": Normalization of Monetary Policy After QE

On October 29, 2014, the Fed announced that it would stop making large-scale asset purchases at the end of the month. In that case, the balance sheet would not be much smaller than its current size of $4 trillion when normalization is completed—more than four times larger than its pre-crisis size. In order to raise the federal funds rate in the presence of large reserves, the Fed has raised the two market interest rates that are close substitutes—it has directly raised the rate it pays banks on reserves held at the Fed and used large-scale reverse repurchase agreements (repos) to alter repo rates.
Congress has delegated responsibility for monetary policy to the Federal Reserve (the Fed), the nation's central bank, but retains oversight responsibilities for ensuring that the Fed is adhering to its statutory mandate of "maximum employment, stable prices, and moderate long-term interest rates." To meet its price stability mandate, the Fed has set a longer-run goal of 2% inflation.
The Fed's control over monetary policy stems from its exclusive ability to alter the money supply and credit conditions more broadly. Normally, the Fed conducts monetary policy by setting a target for the federal funds rate, the rate at which banks borrow and lend reserves on an overnight basis. It meets its target through open market operations, financial transactions traditionally involving U.S. Treasury securities. Beginning in 2007, the federal funds target was reduced from 5.25% to a range of 0% to 0.25% in December 2008, which economists call the zero lower bound. By historical standards, rates were kept unusually low for an unusually long time to mitigate the effects of the financial crisis and its aftermath. Starting in December 2015, the Fed has been raising interest rates and expects to gradually raise rates further. The Fed raised rates once in 2016, three times in 2017, and four times in 2018, by 0.25 percentage points each time. In light of increased economic uncertainty and financial volatility, the Fed announced in January 2019 that it would be "patient" before raising rates again.
The Fed influences interest rates to affect interest-sensitive spending, such as business capital spending on plant and equipment, household spending on consumer durables, and residential investment. In addition, when interest rates diverge between countries, it causes capital flows that affect the exchange rate between foreign currencies and the dollar, which in turn affects spending on exports and imports. Through these channels, monetary policy can be used to stimulate or slow aggregate spending in the short run. In the long run, monetary policy mainly affects inflation. A low and stable rate of inflation promotes price transparency and, thereby, sounder economic decisions.
The Fed's relative independence from Congress and the Administration has been justified by many economists on the grounds that it reduces political pressure to make monetary policy decisions that are inconsistent with a long-term focus on stable inflation. But independence reduces accountability to Congress and the Administration, and recent legislation and criticism of the Fed by the President has raised the question about the proper balance between the two.
While the federal funds target was at the zero lower bound, the Fed attempted to provide additional stimulus through unsterilized purchases of Treasury and mortgage-backed securities (MBS), a practice popularly referred to as quantitative easing (QE). Between 2009 and 2014, the Fed undertook three rounds of QE. The third round was completed in October 2014, at which point the Fed's balance sheet was $4.5 trillion—five times its precrisis size. After QE ended, the Fed maintained the balance sheet at the same level until September 2017, when it began to very gradually reduce it to a more normal size. The Fed has raised interest rates in the presence of a large balance sheet through the use of two new tools—by paying banks interest on reserves held at the Fed and by engaging in reverse repurchase agreements (reverse repos) through a new overnight facility. In January 2019, the Fed announced that it would continue using these tools to set interest rates permanently, in which case the balance sheet may not get much smaller than its current size of $4 trillion.
With regard to its mandate, the Fed believes that unemployment is currently lower than the rate that it considers consistent with maximum employment, and inflation is close to the Fed's 2% goal by the Fed's preferred measure. Even after recent rate increases, monetary policy is still considered expansionary. This monetary policy stance is unusually stimulative compared with policy in this stage of previous expansions, and is being coupled with a stimulative fiscal policy (larger structural budget deficit). Debate is currently focused on how quickly the Fed should raise rates. Some contend the greater risk is that raising rates too slowly at full employment will cause inflation to become too high or cause financial instability, whereas others contend that raising rates too quickly will cause inflation to remain too low and choke off the expansion.