The Fed is best known for its role in making and carrying out the country's monetary policy - that is, for influencing money and credit conditions in the economy to promote the goals of high employment, sustainable growth and stable prices.

There is nothing that the Fed can do to guarantee that our economy will grow at a healthy pace or that it will provide a job for everyone who wants one. However, the Fed can create an environment that is conducive to economic growth. The Fed does that by pursuing a goal of price stability - that is, by maintaining inflation at a rate that does not affect business or household spending decisions.

Inflation is caused by excess growth of money and credit relative to the supply of goods and services in the economy. Money includes cash in circulation, plus the deposits that people and businesses have in bank accounts; credit refers to the funds that banks and other lenders can lend. The Fed must make sure that money and credit don't grow too rapidly or slowly. Watch what happens when money and credit rise too rapidly or too slowly.

The Fed must see to it that money and credit grow at an appropriate pace - a pace conducive to sustained economic growth and an inflation rate that does not affect business or household decisions. The most frequently used tool the Fed has is open market operations - buying and selling previously issued U.S. Government securities, or IOUs of the federal government. Watch how the Fed creates money in this simplified model.

The Fed changes the money supply by increasing or decreasing reserves in the banking system through the buying and selling of securities. The changes in the money supply, in turn, affect interest rates.