Monetary policy is used to try to expand or contract the economy in the face of unemployment or inflation, mainly with monetary tools which manipulate interest rates and the money supply. Monetary policy is implemented by the Board of Governors of the Federal Reserve Banks and the decisions makers are independent of the President or Congress. The Board of Governors of the Federal Reserve are appointed by the President and confirmed by the Senate, so the executive and legislative branches of our government do have some influence over the Federal Reserve, but the members of the board are appointed for 14 years. There are 7 members of the board and the members serve staggered terms, a new one being appointed every two years. Board members can only serve one term. According to the Wikipedia page, Federal Reserve System, there are currently two vacancies on the board because Obama is having difficulty getting his nominees through the Senate.
Some tools of monetary policy are open market operations, the reserve ratio, the discount rate, and quantitative easing. Open market operations involve the Federal Reserve banks buying or selling either repurchase agreements (for the very short term) or government securities in order to keep interest rates level. If interest rates are going up, a Federal Reserve bank buys government securities from a commercial bank, then the commercial bank has more money to lend and the money supply goes up and interest rates go back down. If interest rates are going down, a Federal Reserve bank sells government securities to a commercial bank, then the commercial bank has less money and the money supply goes down and interest rates go back up.
The effect of the reserve ratio is described in previous blogs. Currently, manipulating reserve ratios is not a large part of monetary policy in the United States, since most of the accounts that still have a reserve ratio requirement are checking accounts and are only a small portion the larger measures of the money supply.
The discount rate is the interest rate charged to commercial banks that borrow, usually for the short term, from the Federal Reserve system because of problems with liquidity. When commercial banks borrow from the Federal Reserve system using the discount rate, the borrowing is called borrowing from the discount window. Changing the discount rate has an effect on the different interest rates within an economy and, as such, an effect on the money supply. Increasing the discount rate makes the borrowing of money more expensive, so has a contracting effect on the money supply. Decreasing the discount rate makes borrowing cheaper, so has an expansionary effect on the money supply. From what I have read, the discount rate is not currently a big part of monetary policy.
Quantitative easing involves the government buying financial assets from commercial banks and other financial entities in order to put more money into the economy. According to the Widipedia article Quantitative Easing, open market operations are used to maintain interest rates, but, when interest rates are already low and the economy is stagnating (called a liquidity trap), quantitative easing is used to expand the money supply and put downward pressure on interest rates out into time. The purpose of quantitative easing is to expand the money supply when interest rates already low and there is no wiggle room for more traditional methods of monetary policy. With open market operations, the Federal Reserve banks buy and sell short term government securities from and to commercial banks in order to affect the interest rate. With quantitative easing, different kinds of financial assets are bought that are longer term than with open market operations, which affects longer term interest rates. The sellers include more than commercial banks and the assets include more than government securities.
Monetary policy, as opposed to fiscal policy, seeks to expand or contract an economy through the ease of access to money, which depends partly on the interest rate. If the supply of money goes up, interest rates should go down. If the supply of money is reduced, interest rates should go up. Fiscal policy seeks to expand or contract an economy through buying goods and services, and thus increasing the amount of money in the economy available to be spent (rather than borrowed).