Federal Reserve - Research Paper Example

Federal Reserve Factors That Influence the Federal Reserve in Adjusting the Discount Rate The Federal Reserve adjusts to the discount rate depending upon whether they want to encourage or discourage borrowings. In an inflationary and burgeoning economy the Federal would raise the discount rate so that economy calms down and vice versa (About.Com 2012).The Discount Rate Affect the Decisions of Banks in Setting Their Specific Interest RatesDiscount rate affects the banks in setting their specific interest rates because that is the interest rate that they pay to the Fed for their borrowings from them.

If the discount rates are moving up, the commercial banks need to revise their rates upwardly and opposite is also true to remain competitive (About.Com 2012).Monetary Policy Aim to Avoid InflationMonetary policy is used to control inflation by revising the reserve ratio requirement or increasing the funds rate so as to reduce the demand of goods in the economy. Monetary policy influences the money supply and by this tool it controls the inflation (The Federal Reserve System 2012).Monetary Policy Control the Money SupplyOpen market operation is a tool that the Fed uses to increase or decrease the money supply.

Through open market operations the fed buys or sells treasury bills, Notes or bonds. This is the way the Fed alters total reserves in the banking system. When the Fed buys $50 million of bonds from a bank, the banks reserve would increase by the same amount and eventually that money would be loaned out by the bank. The $50 million increase in bank reserves would cause an equivalent increase in their monetary base (Colorado 2011).A stimulus program (through the money multiplier) affects the money supplyWhen the Fed undertakes a stimulus program, it essentially increases the money supply in the economy.

As seen in the above example, the money supply will increase by $50 million times the money multiplier. If the money multiplier is 5, the money supply will increase by $250 million and obviously that would provide big impetus to the economy (Colorado 2011).Present Situation and Steps UndertakenCurrently, the Fed discount rates are quite low, near to 0.25% that indicates the government wants to give boost to the economy by increasing money supply. After 2008 meltdown, the government bought long-term treasury bonds and notes.

This indicates that the Fed is making all efforts to increase money supply to revive the market (The Federal Reserve System 2012).ReferencesAbout.Com (2012). Bank Reserves and the Discount Rate. Retrieved July 12, 2012 from http://economics.about.com/od/monetaryandfiscalpolicy/a/bank_reserves.htmColorado (2011). The Federal Reserve and Monetary Policy. Retrieved July 12, 2012 from http://www.colorado.edu/Economics/courses/econ2020/section11/section11-main.htmlThe Federal Reserve System (2012).

How does monetary policy influence inflation and Employment. Retrieved July 12, 2012 from http://www.federalreserve.gov/faqs/money_12856.htm