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Banking Crisis - Research Paper Example

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The Federal Reserve sets the nation’s monetary policy to promote the objectives of maximum employment, stable prices, and moderate long-term interest rates. (Federal Reserve System. In a country’s economy the factors like inflation, interest rates and employment are interdependent. …
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Banking Crisis
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Download file to see previous pages It is important to ensure close co-ordination between the Federal Reserve and the Government, because monetary policies should be complementary to fiscal policies for achieving the country’s objective of sustainable and long term economic growth. Evolution of Central Banking The concept of Central Bank evolved in the second half of the 19th century. The banking institutions started with commercial purposes or government banks have transformed into central banks in most of the countries. Bank of England model has been adopted by several countries. Central banks became the lender of the last resort and started issuing notes. In the aftermath of the great depression the independence of the central bank has been curtailed in US. However, gold standard and laissez faire brought back independence to central bank to ensure monetary stability. The US Federal Reserve came into existence in 1913 through passing of The Federal Reserve Act. Panic in 1907 in banking circles gave rise to demands for reforms in banking sector and the National Monetary Commission was set up for this purpose. In mid 1990’s “in the wake of Russian default, the Fed lowered short term interest rates to minimize the consequences of international financial conditions for the US economy and to ameliorate those conditions abroad.” (Neely 35) Many world countries have agreed to adopt gold standard system in Bretton Woods Conference in 1914 which envisaged economic discipline among the nations. The role of central bank has increased substantially since stability of the currency is an important factor in international finance. But, gold standard has failed due to devaluation of currencies by several countries to protect their national economies. The International Monetary Fund created in Bretton Woods in 1944 with the aim of preserving global monetary order introduced fixed exchange rates of the currencies in relation to US Dollar or gold. This system has also failed due to various practical difficulties. Introduction of fluctuating exchange rates later coupled with internal economic factors has increased the clout of central banks further and most of the countries started adopting fluctuating exchange rate system based on demand and supply. Paul Krugman stated “Under the "floating" exchange rates we have had since 1973, exchange rates are determined by people buying and selling currencies in the foreign-exchange markets. The instability of floating rates has surprised and disappointed many economists and businessmen, who had not expected them to create so much uncertainty.” From the simple bartering system, the monetary order has undergone changes over years in tune with the dynamic economic environment, technological developments and introduction of exotic derivative products in banking and financial services sector. In determining the value of money in modern economy, the fiscal measures of governments and the monetary control measures of the central bank play very crucial roles. David Kupelian stated “Despite the varied theories espoused by many establishment economists, it was none other than the Federal Reserve that caused the Great Depression and the horrific suffering, deprivation and dislocation America and the world experienced in its wake. At least, that’s the clearly stated view of current Fed Chairman Ben Bernanke.” The globalization phenomenon gaining momentum during the recent years ...Download file to see next pagesRead More
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