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Within the context of monetary policy and the Federal Reserve Board, how does an...

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armyof32000 | Salutatorian

Posted July 28, 2013 at 4:30 PM via web

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Within the context of monetary policy and the Federal Reserve Board, how does an active policy differ from a passive policy?

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kipling2448 | (Level 2) Educator Emeritus

Posted July 28, 2013 at 5:18 PM (Answer #1)

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There are very important fundamental distinctions between active and passive approaches or polices when the Federal Reserve Board is contemplating modifications to the existing monetary policy.

The Federal Reserve Board is a small group of individuals who meet to establish monetary policies according to the prevailing or projected economic conditions for the country as a whole.  Interest rates can be adjusted upward or downward depending upon the Board's assessment of near-term inflationary trends, or upon its determination of longer term requirements.  Some of the options, or "tools," available to it are well-established procedures that function almost like a checklist of actions to be taken under certain conditions, and may include doing nothing at all.  The common demoninator is the commitment to follow or coordinate with the fiscal policies established by other parts of the government responsible for tax policy.  This set of established options is referred to as "passive policy."  Passive policy, being something of a preapproved checklist of procedures, is usually considered the lower-risk approach to making adjustments to monetary supply.  It also minimizes the direct influence on monetary policy of the individual members of the Board, as the checklist existed before their appointments, and will exist long after their terms expire.

In contrast, "active policy" refers to the practice on the part of the Federal Reserve Board of exercising greater levels of discretion in how its members respond to economic conditions.  Board members are less constrained in how they implement policies with regard to addressing existing rates of inflation or in how they propose to prepare for future rates of inflation, and are less tied to fiscal policies established outside of the Federal Reserve. 

The dynamics of how fiscal and monetary policies are established are complex, and involve many players, including the congressional committees with jurisdication over tax issues, the Department of the Treasury, and the National Economic Council within the Office of the President. 

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