Let's have a look at the role of the Federal Reserve, or the Fed. The Fed has many jobs. It regulates and supervises banks. It tries to maintain the stability of the financial system. But more importantly, for interest rates, it manages monetary policy. And it does that in order to ensure maximum employment, in order to maintain stable prices, and to moderate long-term interest rates. The Fed has a number of key tools at its disposal. First of all, and most importantly, it can perform open market operations. Open market operations is where the Fed buys or sells securities, usually treasury bonds. And when it buys bonds, it increases the money supply. And when it sells bonds, it decreases the money supply. Secondly, the Fed can set the discount rate. The federal discount rate is the interest rate that the Fed charges banks for short-term loans to meet those banks' liquidity needs. And, finally, the Fed can set reserve requirements. Reserve requirements is the portion of deposits that commercial banks are required to keep in their vaults or on deposits at the Federal Reserve. This is like a liquidity buffer.

We often hear about the Fed easing or tightening monetary policy. What does that mean? Well, if the Fed wants to stimulate the economy and promote economic growth, we call that easing. What the Fed does then is that it increases money supply. So primarily it buys securities from dealers. It could also decrease the reserve requirements or lower the discount rate. If the Fed likes to slow down the economy, maybe inflation has gotten out of hand, the Fed tightens monetary policy. That means they reduce the money supply. They sell securities to dealers. They could also increase reserve requirements or raise the discount rate.