Final answer:
The Federal Reserve's management of interest rates and money supply through its monetary policy aims to influence economic activity, stabilize the economy, and control inflation. This is achieved using tools like open market operations and adjusting reserve requirements.
Step-by-step explanation:
The Role of the Federal Reserve in Monetary Policy
The actions that the Federal Reserve takes to set interest rates and determine the size of the money supply in the nation are collectively referred to as monetary policy. The Fed's responsibility to establish monetary policy was given by the Federal Reserve Act of 1913. Through monetary policy, the Federal Reserve manages interest rates and credit conditions, which in turn can influence the level of economic activity, stabilize the economy, and control inflation.
A few traditional tools used by the Federal Reserve in implementing monetary policy include open market operations. These operations help the Fed to control the money supply by buying and selling government securities, which affects reserve levels at banks and, consequently, interest rates.
Moreover, the Fed's ability to alter interest rates directly impacts the cost of credit and borrowing. By manipulating these rates, the Fed can either encourage economic growth by making borrowing cheaper or rein in inflation by making borrowing more expensive. This dual role helps to ensure a balance between economic growth and price stability.