The Federal Reserve - Assignment Example

The Federal Reserve of Introduction The Federal Reserve is considered as the regulatory and supervisory authority of United States. It is assigned with the responsibility of maintaining stability in the economy. The Fed supervises the banking and the financial institutions in United States. It conducts the monetary policy by fixing the rate of interest and controlling the overall supply of money and credit in the economy. The Federal Reserve affects the inflation and economic growth in the economy. The main duties performed by Fed are supervising and regulating the banks and the financial institutions, controlling and supervising the amount of currency made as well as destroyed and maintain strong payment system in the economy. It applies various tools for controlling the money supply in the economy. The Fed adopts adequate measures for controlling the unexpected fluctuations in the interest rate. Question 1 The Federal Reserve plays an important role in stabilizing the economy of United States of America after the market traumas. The Federal Reserve explains the role of the monetary policy in influencing the availability of credit and cost for attainment of goal such as providing sustainable employment and achieving a stable price level. The economy of United States maintains a complex combination of financial, manufacturing, banking and agricultural industry. In order to maintain balance in its services, the economy of US is largely dependent on foreign trade and commerce and investment for generating revenue and retaining wealth in the economy. Federal Reserve System plays a vital role in assisting the small industries. It is considered as the largest buyer in the world. The small businesses in United States utilize the revenue received for creating more job opportunities which will facilitate the economy towards growth and development. The Federal Reserve System focuses on innovation for assisting the small business. The Federal Reserve performs the role as a regulator and Central Bank of the economy. It appoints and supervises the designated firms and agencies for maintaining soundness and safety in the financial institutions of the economy. The margin requirements are set by Fed for purchasing of securities in private transactions. The main reason for fixing the margin requirements is to determine the amount of purchase that can be made on credit. The Fed regulates the state and the foreign banks. It establishes certain specific rules and guidelines in the areas of capital adequacy that can be applied to the banks. It is also responsible for regulating the wholesale and retail payment system for maintaining soundness and safety in its operation. Therefore the regulatory responsibility is performed by Fed efficiently as a lender of the last resort assist in identifying the risk for responding to the financial stability of the economy. It has also restructured its internal operation for stabilizing the economy. Question 2 The economic indicators that are frequently used by the Federal Reserve System in stabilizing the US economy are through HDI and Gross Domestic Product. The policy makers of the Federal Reserve evaluate the changes in the rate of inflation by supervising different price indexes. Human development index is considered as one of the most important indicator for determining the growth and prosperity. The Human Development index mainly comprises of the life expectancy index, income index and education index which includes the purchasing power parity and the gross national income. The average life expectancy index compares the mortality rate of an individual country with the global life expectancy rate. The education index measures the literacy rate of a particular country in comparison to the global literacy rate. The third component of the Human Development Index is the Gross National Income per capita which ranks the countries on the basis of the social and economic development parameters. The monetary policy in the short run is affected by the growth in the short run. The FED has focused on decreasing its GDP rate by 2015. Since the financial crisis, it has remained consistent high in its GDP rate. The Federal Reserve maintains and supervises the rate of GDP in order to control the inflation and recession in the economy. The GDP is considered as one of the most important indicator in estimating and analyzing the stability of the economy. The GDP measures the total value of all goods and services produced by the country within a specific period of time. (Clark, 2013) Question 3 The Federal system manages and supervises the money supply and credit in three different ways. The size of the reserves determines the amount of deposit that the financial institution can maintain as outstanding and the liabilities that is associated with the amount of assets acquired by these financial institutions. The banks in US are required to maintain a definite proportion of their deposit against their withdrawals. This varying amount is called the reserve ratio. The Federal Reserve is responsible for controlling the amount of money in circulation. It affects the liquidity in the market. Presently the banks in US are expected to maintain a deposit of 0 to 10% that is required for qualifying in the net transaction account in the Federal Reserve’s. The amount or the percentage of deposits varies according to the size of the banks. The Fed can change or modify the reserve requirements which specify the amount of deposit held by the customers. The most important method adopted by Fed to maintain credit and money supply in the economy is through open market operations it includes buying of the US securities and selling it to the private investors. The Fed is engaged in buying securities with the newly issued currency which increases the capacity of the depository institutions in expanding the money and credit supply in the economy as well as expanding the reserve base. The reverse transaction can be applied if the Fed Reserves decide to sell off its securities from its portfolio. The last step or measure adopted by Fed in controlling money supply in the economy is by altering its two different interest rates. These interest rates generally influence and affect the market rates in the economy. The Fed allows the depository institutions to borrow directly at a discount on temporary basis. These financial institutions can discount some of their assets at Fed fort obtaining reserves. The discounts are generally offered on an overnight basis by Fed over its Federal funds (Friedman, 1998). Question 4 The strength and weakness of using monetary policy in comparison to the fiscal policy while promoting the economic activity and preserving the price stability in the economy can be explained by focusing on the weakness of the fiscal policy. The business will slow down the rate of production which will decrease the amount of profit resulting in decrease of the business investments. The government spending will lead to the reduction of tax which will increase the rate of interest. The increasing rate of interest discourages the business and the individuals from borrowing money for investment and spending. Monetary policy can be defined as the decision taken by the government regarding the fixation of interest rate and money supply in the economy. The monetary policy in United States is mainly determined by the Federal Reserve’s which performs the function as the Central Bank of United States. The monetary policy is used for increasing and decreasing the supply of money in the economy. The Fed increases the supply of money in the economy by purchasing the government securities such as the treasury bonds. When Fed sells these securities in the market, it will generate more money in the economy by trading the dollars in place of securities. The Federal Reserve System plays an important role in promoting efficiently towards stabilizing the prices, maximizing the rate of employment and the long term interest rate. The main disadvantage of the fiscal policy is that increases the debt burden of the economy resulting in the situation of increasing inflation in the economy. The expansionary fiscal policy decreases the national income of the country. During the course of business cycle, the aggregate rate of spending in the economy is expected to increase which results in increasing budget deficit in the economy. Therefore in order to stabilize the economy the various instruments of monetary policy are required to be implemented. The fiscal policy tends to influence the fluctuations in the interest rate in the economy. The monetary policy implements adequate measures for controlling the fluctuations in the interest rate (Labonte, 2015). Question 5 The effect of Federal Reserve in terms of the aggregate demand and supply can be explained in reference to the problem encountered by the US economy in determining the rate of unemployment prevailing in the economy. The rate of unemployment either increases or decreases the inflation rate. The unemployment rate is related to the supply of labor in the market. The relation between the rate of unemployment and the supply of labor can be explained in relation to demand and supply model. With the increase in the demand for workers the rate of employment increases and with the increase in employment opportunities the supply of labor also increases; therefore there is a direct relationship between the unemployment rate and supply of labor in the economy. The Federal Reserve is focusing on maintain a balance between the demand and supply. The aggregate supply can be defined as the total supply of all goods and services produced by the economy and the aggregate demand id the total demand for goods and services in the economy. With the decrease in confidence of the customers, the rate of spending of the public also decreases which results in the fall of demand thus reducing the prices and real output leading to a situation of recession in the economy. When there is an increase in money supply in the economy, the demand of the consumer also increases which increases the aggregate demand thus leading to a rise in price and real output. Figure 1: Aggregate demand and supply (The Federal Reserve, 2012) The demand for money comprises of the borrowings of the consumers which include homes and cars, the borrowings of the firm consist of the items such as the equipments and factories and also the borrowings of the government to finance the national debt. The money supply is fixed by the Fed which is considered as the Central Banking System for United States. The demand and supply of the money determines the rate of interest that is required to be paid for the use of the borrowed money. If the Federal Reserve raises the money supply, the interest rate will fall and as a result the borrowing of money becomes less expensive. On the contrary when the Federal Reserve’s decreases the money supply, the rate of interest increases, therefore fewer amounts will be spent and borrowed due to the higher cost of borrowing. Figure 2: Graph of Money market Therefore the Federal Reserve can control the demand and supply of money in the economy by applying the three primary tools and techniques during the time of crisis and economic recession. Conclusion The Federal Reserve plays an important role in influencing the availability of credit and cost of money in the economy. Since the expectation of the various market participants plays an important role in determining the economic growth and price, the monetary policy can be explained as the means of formulating the policies directives and actions of Fed that will influence the future perceptions. The Federal Reserve experiences supervisory and regulatory authority over various financial institutions in United States. It carries out its operation with other states and Federal entities for promoting soundness in its operations. It is also considered as the lender of the last resort. The Fed acts as a buffer against the unexpected demand and supply fluctuations prevailing in the economy. This contributes for the effective performance of the financial institutions that decreases the unwanted fluctuations in the interest rates. References Clark, T. (2013). Nominal GDP targeting rules, Retrieved from < https://www.kansascityFed.org/publicat/econrev/pdf/3q94clrk.pdf >. Friedman, M. (1998). The role of monetary policy, The American economic review, 28(1), pp. 5-8. Labonte, M. (2015). Monetary policy and the Federal Reserve: current policy and conditions. Retrieved from < https://www.fas.org/sgp/crs/misc/RL30354.pdf > . The Federal Reserve (2012). Monetary policy and the economy, Retrieved from < https://www.dallasFed.org/assets/documents/educate/everyday/ev4.pdf >. Read More