Macroeconomics › Section O · Monetary policy and bank regulation › Topic O.4
How a central bank carries out monetary policy
When the news says the Fed raised rates, what did it actually do? Textbooks describe three classic tools that work by changing the quantity of reserves; today the Fed works mainly by setting the interest rates it pays and charges. This topic explains both.
In this topic
- Steering one overnight rate
- Classic tool 1: open market operations
- Worked example: an open market purchase
- Classic tools 2 and 3
- Why the classic method stopped working
- Interest on reserve balances: the floor
- The rest of the toolkit
- Worked example: the October 2026 settings
- Managing the balance sheet
- Common mistakes to avoid
- Key takeaways
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