The Federal Reserve
Jermaine C. Taylor
ECO320 Money & Banking
March 2, 2014
Prof. Diana Bonina, Ph.D.
The Federal Reserve established on December 23, 1913 when President Woodrow Wilson signed the Federal Reserve Act into law. Although started in 1913, actual operations of the Reserve began in 1914. In order to provide the country with a safer financial system, Congress created The Federal Reserve System as the central bank of the United States.
Today, the Federal Reserve’s responsibility falls into four general areas: conducting the nation’s monetary policy; supervising, regulating and other soundness of the country’s financial system; maintaining the ...view middle of the document...
When the banks borrow from the Federal Reserve, they pay an interest rate called the Discount Rate. Although closely related, the discount rate is usually lower than the federal funds rate. The discount rate is important because it is a visible announcement of a change in the Fed’s monetary policy and gives the rest of the market insight into their plans. When the discount rates are high, banks will have less incentive to borrow, thus lowering the money supply in the system.
When the economy is an inflationary gap, the Federal Reserve will adopt a contractionary monetary policy to decrease the money supply in the market by selling securities, raising the reserve rate, and/ or increasing the discount rate. When the economy is in a recessionary gap, the Federal Reserve will adopt expansionary monetary policy to increase the money supply in the market by buying securities, lowering the reserve rate, and/ or decreasing the discount rate.
Monetary Policy is the actions of a central bank, the currency board of other regulatory committees that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy maintained through actions such as increasing the interest rate, or changing the amount of money a bank may need to have in its vaults. Monetary policy is also one of the ways that the U.S. government attempts to control the economy. If the money supply grows too fast, the rate of inflation will increase; if the growth of the money supply is slow, then economic growth may also be slow.
The Federal Reserve and other central banks can use monetary policy to achieve low inflation in the long run and affect economic output and employment in the short run, but these goals sometimes conflict. Reducing interest rates to expand the money supply and stem rising unemployment rates during a recession, for example, could spark future inflation if monetary policy remains expansionary for too long. Another weakness is that a large modern economy such as that of the U.S. and other world economic powers, can take a long time for changes to go into effect when made by the Federal Reserve.
Monetary policy, though often strongest when used in coordination with fiscal policy, has several advantages to fiscal policy. For one, fiscal policy has a tendency to cause massive inflation. Government infusion of money into the economy through spending can cause massive increases in inflation. To slow inflation, it is hard to cut spending and raise taxes politically, thereby contracting the economy, and thus it is hard to cut spending and raise taxes politically, thereby contracting the economy. Monetary policy, by contrast can cause inflation, but raising and lowering interest rates, and increasing and decreasing the money supply tend to be effective ways of economic control that are not excessively inflationary. Using the tools of monetary policy, the Federal Reserve can affect the volume of money and credit and their...