Can You Explain The Monetary Transmission Mechanism Of Federal Reserve?

The monetary transmission mechanism is the route by which changes in the supply of money are translated into changes in output, employment, prices and inflation. For concreteness, assume that the Federal Reserve is concerned about inflation and has decided to slow down the economy. There are five steps in process:
1. To start the process, the Federal Reserve takes steps to reduce bank reserves. The Federal Reserve reduces bank reserves primarily by selling government securities in the open market.
2. Each dollar reduction in bank reserves produces a multiple contraction in checking deposits, thereby reducing the money supply. Since the money supply equals currency plus checking deposits, the reduction in checking deposits reduces the money supply.
3. The reduction in the money supply will tend to increase interest rates and tighten credit conditions. With an unchanged demand for money, reduced supply of money will raise interest rates. In addition, the amount of credit available to people will decline.
4. With higher interest rates and lower wealth, interest sensitive spending especially investment will tend to fall.
5. Finally the pressure of tight money by reducing aggregate demand will reduce income, output, jobs, and inflation.

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