The Federal Reserve Controls the American Economy - Term Paper Example

?Running head: The Federal Reserve The Federal Reserve Controls the American Economy Insert Insert Grade Insert 09 May Introduction The Federal Reserve controls the American economy because of the prominent role it plays in managing the flow and circulation of currency and the interest fees. The Federal Reserve is the fundamental bank of America initiated in 1913 through the ratification of Federal Reserve Act as a reaction to the financial apprehensions of 1907 (Greider 67). However, the functions of the Federal Reserve have widened over time as the bank develops to meet the tests of organization in the economy. It is obvious that the economy is all about managing finances, and since the Federal Reserve has oversight authority over the country’s financial administration it controls the entire economy. As a central bank, the Federal Reserve sets the rates for other commercial banks thus influencing the interest rates. Similarly, the Federal Reserve determines the circulation of money thus influencing inflation and flow of money. Through these two dynamic roles of the Federal Reserve, it is evident that the US economy lies directly in the hands of the Federal Reserve. Several developments in the US economy, like the great depression, have seen the augmentation of the evolution and transformation of the roles of the Federal Reserve. The congress developed three crucial goals regarding monetary policy in the Federal Act namely; utmost employment, constant prices, and reasonable long-term interest rates. To be relevant to the growing economic realities the roles of Federal Reserve have grown to include other areas like performing the nation's monetary policy, managing and regulating banking entities, maintaining the steadiness of the financial arrangement and offering financial services to reservoir organizations, the U.S. government, and abroad executive institutions. The Beige Book is a manual usually published by the Federal Reserve that contains research on various aspects of the US economy. Structure of the Federal Reserve System and Its Core Functions The federal system structure constitutes of governors selected by the president, Federal Open Market Committee, twelve local Federal Reserve Banks situated in main cities all over the nation, plentiful surreptitiously owned U.S. affiliate banks and assorted advisory committees (Willis 48). The FOMC is the board in charge of establishing monetary policy, which comprises all seven affiliates of the Board of Governors along with the twelve local bank heads. Nonetheless, simply five bank presidents take part in an election at whichever time. The Federal Reserve System intention is to serve the purposes of both the broad public as well as clandestine bankers. The outcome is a structure that is painstakingly unique with central banks. Federal Reserve is further remarkable in that Department of the Treasury, an entity out of the central bank, makes the currency used. The Federal Reserve is independent, and its decision needs not to be approved by the executive or government. Hence, it base its mandate on laws ratified under which it operates with autonomy under congress oversight. However, the executive select the leaders of the Federal Reserve while the congress does the confirmation. The government has some control over the Federal Reserve because it sets the remuneration of the highest leaders of the system. All profits derived by the Federal Reserve System go to the government. Federal Reserve System and the US Economy The Federal Reserve has oversight authority on the American economy, therefore, exercising overall control on the country’s economy (Meltzer 32-35). The functions of the Federal Reserve regard overall economic management. The Fed controls inflation in a manner that keeps recession at bay. Other significant roles of the Fed in US economy include supervision of the country’s banking system to cushion customers, maintaining steadiness of monetary markets and confine probable crises, and functioning as a central bank for banks, government and international bank. Through controlling inflation, the Federal Reserve exercises authority in the American economy. Inflation refers to price increases that are a common phenomenon in every economy. Inflation is a central pillar of any economy and hence any authority that reserves the right to handle and regulate inflation controls the economy directly. Managing inflation is a core function of the Federal Reserve whose execution is through managing credit. Credit signifies the largest element of money supply, and through regulating credit, the Fed manages inflation. One sure way of managing inflation is through the increase of interest rates as well as making credit quite costly. Such mechanisms decrease the supply of funds in circulation thus curbing inflation. Managing inflation is a core economic function because inflation is a factor that inhibits growth along with destroying the gains of economic development. Hence, inflation and its regulation are crucial parameters in the operations and profile of the general economy. By regulating inflation, the Fed micro-manages the economy through regulating money circulation as well as determining the interest rates. In the absence of inflation threat, the Fed lowers the cost of credit through keeping interest rates low. Such a move augments liquidity, catalyses growth, and minimizes incidences of unemployment. In its duty of governing inflation, the Fed monitors the rate of inflation via the core inflation rate weighed by the consumer price index. The two reliable methods through which Fed manages inflation are direct economic parameters that affect the day to day economic activities of the country. Cost of credit and money supply remain the key components of economic activity. Since these two functions are directly under the Fed, then it is obvious that the fed exercise direct control over economic activities of the country’s economy. For instance, through managing supply of money the Fed has full control of the nature and intensity of business transactions in the country. This means that the Fed can augment business activity and growth at the same time slow growth through the tool of money supply. Because inflation refers to high prices or too much fund in circulation, it is only the Fed that can boost or reduce the circulation of funds. Cost of credit is incidental to commercial activities that spur economic activity in the country. The Fed exercises authority over the cost of credit at any given time thereby determining how borrowers pay for loans and borrowed capital. Through determining interest rates, the Fed can either spur entrepreneurial activity or slow it. Since entrepreneurship is crucial in economic activity and because borrowing is essential in business, the Fed has supreme authority on the daily commercial activities of businesses that constitute the national economy. The Federal Reserve manages the US economy through setting the monetary policy, which affects economic growth in myriad ways. For instance, when the Fed reduces interest rates it widens credit along with liquidity increasing the pace of economic growth and job creation leading to inflation (Clark 54). Once there is inflation, the Fed increases the interest rates increasing the cost of credit and reducing the growth momentum thus keeping prices low. Therefore, in virtually all ways, the US economy is in the hands of the Fed that uses the monetary policy to micro-manage the activities of economy. For instance, the aspect of unemployment, which is a vital economic and social parameter, is in the hands of the Fed in the sense that, through the monetary policy, the Fed can augment economic development through the availability of low rate credit creating a lot of job opportunities. Whenever growth comes with its negative connotation of inflation, the Fed reverse its program to lessen liquidity making credit costly, therefore, reigning high prices in the economy. This makes the Federal Reserve the single most entity in the managing of the US economy. In administering the national economy, the Federal Reserve has certain tools that are integral in the oversight authority of the economy. Being a banker of other banks, as well as the government, the Federal Reserve establishes the reserve requirement whereby banks withhold 10 per cent of their deposits every day, which should not be lent out. Incase banks do not have sufficient funds to lent they borrow from other banks at a rate established by the Federal Reserve. FOMC establishes this rate every month. Through the reserve requirement, the Fed exercise control over the entire banking system together with the accessibility and cost of borrowing. The banking sector plays an extremely significant function in the economy, and it is crucial in the availability of credit as well as overall financial services. By controlling credit and the whole banking system, the Federal Reserve dictates the national economy. The Federal Reserve maintains steadiness in the financial system. During the economic crises of 2008, the Fed worked in collaboration with the treasury department to avert financial debacle (Wells 87). It put in place several tools with the intention of administering and averting the crisis; the tools comprised of term auction facility and quantitative easing investor lending facility. The Fed is the chief authority in the financial system, and stability is often its task both on a regular basis and in times of crisis. The economic crises, that have befallen United States, have seen the deep role of Fed; which is the principal entity in the whole financial and economic field. Conclusion In conclusion, the Federal Reserve System is the central bank of the United States plays a supreme role on the country’s economy through its numerous functions. In essence, the Federal Reserve exercises control over the US economy in two ways; money supply and interest rates. The Fed is the custodian of money supply and determines the amount of funds in supply at any given time. The function of controlling circulation by the Fed is through the aspect of lending money both to the government as well as the Fed banks. Therefore, all funds in circulation at whichever time come from the Fed. Money is the most integral facility in the economy because all transactions take place through employing this precious commodity and all commercial activities rely on money as a medium of exchange. Furthermore, the supply of money affects the economy directly making the Fed a regular player in the economic field. Subsequently, the Fed controls the economy through the Fed rate which set the interest rate governing the cost of borrowing. Since the business base its transactions on money, and borrowing is a significant source of capital, by controlling the availability and cost of credit, the Fed determines the daily commercial and financial activities of the economy. Therefore, the Federal Reserve is one single entity in America with supreme power that exercises authority over the entire economy. Hence, the Federal Reserve directly or indirectly controls the US economy through its various functions in the financial system and wider intervention obligations. Works Cited Clark, Cynthia. The American Economy: A Historical Encyclopedia, Volume 1. New ork: ABC-CLIO, 2011. Print Greider, William. Secrets Of The Temple: How The Federal Reserve Runs The Country. Washington: Simon & Schuster, 1989. Print Meltzer, Allan. A History of the Federal Reserve, Volume 2, Book 1; Books 1951-1969. Chicago: University of Chicago Press, 2010. Print Wells, Donald. The Federal Reserve System: A History. New York: McFarland, 2004. Print Willis, Henry. The Federal Reserve; a Study of the Banking System of the United States. Washington: General Books, 2009. Print Read More