The Role of the Federal Reserve in the US Economy - Literature review Example

The role of the Fed (Federal Reserve) in the US Economy Table of Contents 3 2. Introduction 3 3. Literature Review 4 4. Result 6 5. Conclusion 6 6. Suggestions 7 1. Abstract Through the decades, the stability in the development of the US economy has been related to the position of the country’s currency within the international financial system. The structure of the national economy is also another factor influencing the country’s financial performance – referring to the internal and the global market. One of the most important features of the US economy, the Federal Reserve (FED), has been often related to the country’s financial power – despite the FED’s failure to take appropriate measures for preventing the recent financial crisis. Current paper focuses on the examination of the role of the Federal Reserve (FED) in the development of US economy. It is proved that the strategies developed by FED have helped US to be established as a major financial power worldwide. 2. Introduction The intervention of FED in the critical economic plans of the US government has been proved crucial for the stabilization of the national economy. However, not all policies initiated by FED have been successful; on the contrary, the last decade, many failures have been identified in the schemes promoted by FED. These failures have been made clearer after the appearance of the global recession – which has been related to the practices of the US financial institutions. The value of FED for the US economy cannot be ignored. On the other hand, the criteria used by FED for the development of financial policies should be reviewed – taking into consideration the strong turbulences in the global financial market. The Federal Reserve was established in 1913; its establishment was considered by the Congress as a necessary solution under the pressure of the extensive failures of banks across US the years 1907 onwards. Under these terms, the creation of a Central Bank, like the Fed, would ensure the stability of the economy. The main task of Fed is to supervise the US banking system. Moreover, it controls the performance of the US currency and decides on the quantity of money that has to be available across the country (Mankiw 232). 3. Literature Review Under the relevant suggestions of Fed, US banks have to control the level of their loans both to individuals and enterprises; because of the existing limit in the lending potentials of US banks, firms across US tend to borrow money from foreign banks – which do not have such restrictions. In the long term, the above practice has helped towards the increase of power of the US economy. The foreign funds entering the US market – for the financial support of US firms – increased the cash availability in the US market (D’Arista 104). The increase of job positions in firms across USA has been another benefit of the specific policy initiated by Fed. On the other hand, Fishback (387) notes that the policies of Fed usually focus on the protection of dollar within the global exchange market and not particularly on the improvement of economic conditions within US. This trend was more intense in the past when Fed was trying to keep the discount rates at high levels and avoid purchasing bonds (Fishback 387). However, it is noted that if Fed had different priorities, for instance the decrease of unemployment and the limitation of bank failures across US, then it should have followed the opposite direction, lowering discount raters and purchasing bonds (Fishback 387). In accordance with Grey (44) one of the more important activities of Fed as a Central Bank has been its involvement in ‘foreign currency operations’ (Grey 44). Fed entered this field in 1950s and it still has a decisive role in the operations of this type. In fact, these operations have been proved to be crucial for protecting the position of dollar in the global exchange market. One of the most challenging conditions that Fed had to face during the last decades has been the crisis of 2008. When one of the major US investment banks, Bear-Sterns collapsed, the decision of Fed to put the firm under the protection of the state has been proved for the limitation of the crisis across the US economy – even if the actual effects of that decision were not made clear immediately (Smick 12). One the other hand, the above crisis reflected the weakness of Fed to fully meet the requirements set by its establishment. In accordance with Gutmann (109) the objectives of US Central Bank, the Fed, are not the same with those of other Central Banks worldwide (for instance the Bank of England or the European Central Bank). Fed has to monitor the performance of US banks but also, primarily, to ensure the health of the US economy. In practice, this means that the Fed had to take all necessary measures in order to ensure the avoidance of phenomena like the financial crisis of 2008 and the extremely high unemployment rate that followed – the control of which is also included among the objectives of Fed (Gutmann 109). At this point, it could be argued that the crisis of 2008 could not be expected since in 1994 the Fed had already introduced a series of changes in its economic policies – aiming to support the US economy to overcome the effects of the crisis of 1990; it was at that period that the Fed altered its interest policy which became more neutral (Carabenciov et al. 5). The success of the above policy were made clear through the decrease of the unemployment rate in US at quite low levels; this phenomenon was more intense from 1996 up to 1999 leading to the assumption that the US economy had been stabilized and there was no fear for unexpected failures. However, the Fed failed in controlling inflation – which was at high levels – and this failure had caused major concerns in regard to its potential effects on the economy (Carabenciov et al. 5). In order to minimize the risk for the potential appearance of major shocks in the US market, Fed tried to support the stability of the economy using its monetary control tools: ‘the open-market operations, the reserve requirements and the discount rate’ (Mankiw [2] 653). The above efforts were not as successful as expected. However, they have helped to the reduction of the effects of the crisis of 2008 on the US economy. 4. Result The role of Fed in US economy has a series of different forms; primarily, Fed supervises the banks across the country ensuring that the laws related to the banking industry are applied. Through the years, Fed has been involved in a series of crucial activities regarding the development of US economy, like the management of the country’s gold reserves and the allocation of funds for compensation of the war veterans (Fishback 524). Currently, Fed emphasizes on ‘the control of interest rates and the money supply’ (Fishback 524) increasing its power in influencing the performance of US economy. 5. Conclusion The establishment of Fed has been related to the need for a Central Bank that will control the activities of banks across US having the power to decide on the quantity of money available in the market. The performance of Fed up today proves that the above target has been achieved – even not totally. The policies developed by Fed have helped the US economy to achieve a high level of growth – becoming one of the most powerful economies worldwide. However, the effects of its failures have been severe. An indicative example is the recent crisis of the US economy (in 2008), which was rapidly dispersed in markets internationally. At this point, it could be supported that Fed has achieved one of the main targets set by its establishment: the growth of US economy in the context of the international market. On the other hand, the performance of US banks is gradually stabilized. The limitation of the effects of the crisis of 2008 in US has been achieved due to the intervention of the Fed – which, however, delayed to propose appropriate measures. The current status of the US economy – both in terms of the national and the international market – shows the efficiency of Fed in supporting the country’s banking system and guaranteeing the competitiveness of national currency. For this reason, it is suggested that the US economy should continue to support the policies of Fed both in the internal and the international market. 6. Suggestions The increase in currency competition worldwide has led to the increased power of Fed both in the US and the international market. The strategic choices of Fed have helped towards the stability of dollar as a key currency in global financial transactions. However, the development of the recession of 2008 proved that existing policies of Fed should be reviewed. Primarily, Fed should use additional criteria when evaluating the needs of the local economy. The financial prospects of firms would be at equal level with the financial needs of individuals. Moreover, short-term financial projects would be rather preferred – taking into consideration the instability of the global market. Also, it would be necessary that a mechanism is developed for controlling the decisions of Fed aiming to ensure that major failures – like the recent recession – related to the US economy are avoided. Works Cited Carabenciov, Ioan, Ermolaev, Igor, Freedman, Charles, Juillard, Michel. A Small Quaterly Projection Model of the US Economy. New York: IMF, 2008 D’Arista. The Evolution of U.S. Finance: Federal Reserve monetary policy, 1915-1935. M.E. Sharpe, 1994 Dautrich, Kenneth, Yalof, David. American Government: Historical, Popular, and Global Perspectives. Cengage Learning, 2009 Fishback, Price. Government & the American economy: a new history. University of Chicago Press, 2007 Grey, George. Federal Reserve System: background, analyses and bibliography. Nova Publishers, 2002 Gutmann, Peter. Whats the matter with the US economy? AuthorHouse, 2007 Gwartney, James, Stroup, Richard, Sobel, Russell. Economics: Private and Public Choice. Cengage Learning, 2008 Mankiw, Gregory. Brief Principles of Macroeconomics. Cengage Learning, 2008 Mankiw, Gregory. Principles of Economics. Cengage Learning, 2008 [2] OECD. OECD Economic Surveys: United States 2010. OECD Publishing, 2010 Smick, David. The World Is Curved: Hidden Dangers to the Global Economy. Penguin, 2009 Read More