- Raising and lowering the Fed Funds rate,
- Tightening or relaxing the amount of money allowed into the market,
- Raising or lowering the amount of reserves banks need to keep on hand.
In early 2001, the Fed began lowering the Fed Funds rate to avoid a recession. By mid 2004 it began raising the rate to avoid inflation. To avoid triggering the economy back into recession, Alan Greenspan, then Federal Reserve Chairman, heavily signaled the stock market and told investors exactly what he planned to do. This reassured market investors, who kept investing and spending.
The current Fed Chair, Ben Bernanke, has said that the most important role of the Fed, as demonstrated by Greenspan's tenure, is maintaining the public expectations of moderate pricing. He said that the 70's showed us that high inflation leads to more economic volatility, as the public expects and plans for greater changes. The Fed can maintain confidence in the economy by demonstrating moderation, resulting in less extreme changes in public economic behavior.
