The Federal Reserve System - Term Paper Example

?Introduction The role of a central bank in any economy is to manage the monetary policy of the country while ensuring that it manages to achieve broader macroeconomic objectives. One of the key objectives of any central bank is therefore to ensure that inflation within economy remains under control. The flow of money within the economy therefore should be managed in such a manner that it supports the achievement of low inflation, economic stability as well as the low unemployment level within the economy. The Federal Reserve System or Fed is the central bank of US and is operating at both the federal as well as State level. Created in 1913 through Federal Reserve Act, it has served US as one of the leading economic policy making institutes in the country. Its major mandate is to regulate the monetary policy in the country in order to support the broader economic objectives of economic stability, low inflation as well as the unemployment level. President of United States of America appoints the chairman of the Fed along with the seven members of the board of governors. Board of governors is required to serve for the period of 14 years however; the approval of the Congress is required in order to give legal credence to the appointment of the members of the Board. 1 This paper therefore will discuss Fed, how it operates, and its role in the future monetary policy besides discussing its structure and broader objectives it is required to achieve. The Role of Central Bank Before discussing The Federal Reserve System, it is important to present a discussion on the role of central bank within the economy and how it supports it. There are three important tasks or functions of a central bank within an economy i.e. to issue currency notes, regulate monetary policy as well as control the inflation. Based on these broader objectives, a central bank therefore also serves as the banker of the government and serves as lender of lost resort for the banking system in the country. Its role is therefore not just limited to the management of monetary policy within the economy but also to ensure that the whole financial system remains stable and intact. (Blinder) The overall primary function of a central bank is to regulate the monetary policy of a country however, there are also other functions also including managing interest rates within the economy , ensuring that inflation remains within the acceptable level and issuance of currency notes as legal tenders. Managing the level of unemployment at a certain level is also one of the key tasks of a central bank. The recent economic downturn could have resulted into the overall collapse of world financial system however, timely intervention from the central banks of different countries ensured that the financial system remains intact. During the current phase, different central banks therefore took steps which were not traditionally related with the central banks. Steps such as quantitative easing, injecting liquidity into the financial institutions resulted into the complete aversion of the collapse of whole financial system. The Federal Reserve System The Federal Reserve System or Fed is the central banking system in United States of America and was formulated during 1907. Over the period of time, the roles and responsibilities of the Fed as a central bank of the country have also evolved and Fed is now considered as one of the most advanced central banking systems in the world. (Greider) It is to be noted that the Fed as a system evolved as a resulted of the enactment of different laws which gave different powers to Fed. Over the period of time, the overall independence of Fed as a monetary policy authority within the country has increased and Fed is now completely independent in taking its own decisions without significant intervention from the Government or any other body of the State. Fed was initially formulated in order to tackle the initial issues faced by the US economy due to wider fluctuations. However, its role was further broadened and expanded in the wake of the Great Depression of 1930s. During this era, major changes took place in order to ensure that the overall monetary policy of the country remains independent and a more autonomous body to be developed in order to ensure this. The changes which were brought therefore gave Fed complete autonomy while remaining as a government owned institutions. It is therefore to be noted that decisions taken by Fed are not required to be endorsed or ratified by the President. (Wells) Objectives of Federal Reserve System One of the key reasons as to why Fed was enacted to control the banking panics and it also remains one of the key objectives of the bank. Apart from that, it is also required to serve as the central bank for the United States of America fulfilling all the roles and responsibilities which a central bank is required to do. (Broz) It is also required to supervise the overall banking system in the country while at the same time ensuring that the credit rights of the consumers remain protected. Viewing in the light of current economic conditions, these two functions are probably the most sensitive as well as frequently used options of Fed. After the start of current financial crisis during 2007, Fed actively intervened in the economy in order to protect the banking institutions. By providing them emergency funding as well as other support, Fed ensured that the complete collapse of the system could be averted. (Tett). It is also to be noted that the actions of Fed were also directed at protecting the consumer rights and as such took steps to ensure that overall consumer confidence remains high and consumers have access to credit. One of the key macroeconomic objectives of Fed is to regulate the monetary policy of the country and in doing so to achieve maximum employment level, stability in prices as well as moderate interest rates in the long run. Apart from this, Fed is also required to function as the banker to the banks. Its key function however, remains as the regulator of monetary policy in the country and to ensure that it is in-line with the broader macroeconomic objectives set for the whole country. Structure of Federal Reserve System The overall structure of the Fed is based on the board of governors comprising of seven members selected from 12 Federal Reserve Districts. The board of governors is selected by the President however, their appointment need to be ratified by the Congress. The members of the board are selected for the period of 14 years. President of the country is also required to appoint the chairman as well as deputy chairman for the period of four years. It is important to note that both the Chairman as well as the Deputy Chairman of the bank needs to be the sitting governors on the board. There is also a Federal Open Market Committee which largely decides on the open market operations of the bank. Through open market operations, Fed controls the money supply in the country by either purchasing or selling the government securities. It is important to note that Federal Open Market Committee also includes some of the other members also from the different regional Federal Reserve banks. (Krugman and Wells) There are also 12 other Federal Reserve Banks which are part of the Fed as a system with an intermediate legal status. The regional banks therefore partly have the private ownership whereas they are also partly public owned institutions. It is important to note that different nationally chartered banks also hold the shareholding in the regional Federal Reserve Banks. The future role of Fed in Monetary Policy The key objective of Fed is to ensure that it regulates the monetary policy within the country and as such support the broader macroeconomic objectives of achieving price stability as well as low unemployment level. During the recent times, the overall role of Fed in regulating the monetary policy of the country in the wake of the current financial crisis has been active. Fed has undertaken different conventional as well as non-conventional steps to ensure that not only the objective of achieving the economic growth is achieved but the banking system is also remain stable. The current financial crisis was the direct result of the mismanagement by the financial institutions by taking excessive risk. The bursting of sub-prime bubble resulted into the excessive losses for the banks and financial institutions like Lehman Brothers went into liquidation. As a result of this, the overall confidence in the stability of the financial system as a whole was shaken. Apart from this, US economy also witnessed steep decline in the growth rates due to low consumer confidence and lack of aggregate demand. Fed therefore has to take extraordinary measures in order to ensure that banks and other financial institutions remain liquid besides having enough capital to sustain the losses. In order to revive the confidence of the consumers, Fed also reduced the discount rate to almost zero percent so that consumers can borrow at low rates. These steps therefore suggest that Fed has a very important role to play in the future monetary policy of the country. With increasing emphasis on using monetary policy as the key instrument to steer the economy, fiscal policy may not hold its charm for the long. In such situation, the overall role of monetary policy will be more critical and as such Fed will have to perform key role in achieving this. The use of new tools such as quantitative easing indicates that Fed is ready to implement new and non-conventional tools to regulate the monetary policy. In future, Fed therefore may not use traditional tools such as open market operations as the key tools to regulate the economy. It has also been the official stance of Fed that its major role in the future of monetary policy of the country would be to achieve the price stability as well as the fostering of sustainable level of unemployment. In the near future, Fed therefore will be focusing on the management of the interest rates in the economy as the key variables to set the future course of monetary policy in the country.2 Fed will therefore play a much active role in the management of overall economy of the country in the future. With combination of fiscal as well as monetary policy, Fed therefore can deliver effective results as evident from the current economic recovery of American economy and management of interest rates will be the key. Conclusion Fed is the largest central bank in the world with the mandate to regulate the economic system of US through monetary policy. Formulated during early part of 20th century, the overall role and objectives of Fed has evolved over the period of time. The major objective of Fed is to ensure that bank panics could be averted while at the same time ensuring that the general price level within the economy remains stable. Fed is also required to ensure that the unemployment level remains at the low level. During the current economic crisis Fed has undertaken both the conventional as well as new tools and techniques to stimulate growth in the economy. The overall structure of Fed included a board of governors which comprises of seven members chosen for the period of 14 years. President of the country nominate the members and their appointment is subsequently ratified by the Congress. The chairman and deputy chairman of Fed is also chosen among the members of board of governors and are appointed for the period of 4 years. There are also other regional Federal Reserve banks which are also part of the overall Federal Reserve System. The role of Fed in the future monetary policy of the country would be really critical as Fed has to play a leading role in managing the economy and achieving the broader macroeconomic objectives. It is argued that in future, Fed will focus on ensuring price stability as well as keeping the level of unemployment within acceptable range. Bibliography Blinder, Alan S. Central Banking in Theory and Practice . Boston: The MIT Press, 1999. Broz, J. Lawrence. The international origins of the Federal Reserve System. New York: Cornell University Press, 1997. Greider, William. Secrets of the Temple: How the Federal Reserve Runs the Country. New York: Simon & Schuster, 1989. Krugman, Paul and Robin Wells. Macroeconomics. New York: Worth Publishers, 2009. Tett, Gillian. US Banks Borrow $50 Bn via Fed Facility. 18 Feb 2008. 22 July 2011 . Wells, Donald R. The Federal Reserve System: A History. New York: McFarland & Company, 2004. Read More