Federal Reserve and Its Role in the United States Economy - Article Example

Discuss the Federal Reserve in Our Economy         Discuss the Federal Reserve in Our Economy Many people know that there is a government unit which takes care of the economy. This governmental unit executes policies intended to make the nation operate in a smooth way. Nonetheless, a number of investors and individuals do not understand why or how the administration takes part in economic activities. The Federal Reserve is the body that manages the economy in America. The Federal Reserve is the caretaker of the economy of United States. The Federal Reserve is a United States administration bank; this gives it the capacity to manage the financial institutions of the country. The Federal Reserve is perceived as the most prevailing organizations in the world because it manages the largest economy in the globe. An investor should have a basic idea of the Federal Reserve System. It determines the monetary and economic policies that have tremendous outcomes on individuals everywhere and United States (Broz, 1997). This paper will assess and discuss the Federal Reserve and its role in the United States economy. The Federal Reserve System is America’s central bank. This institution designs monetary law, manages and supervises a number of financial institutions. It also plays a significant duty in organizing the payment system of United States. In addition, the Federal Reserve also assists in managing systemic threats in the financial sector and steadies the financial system of the country. The Federal Reserve was established in 1913, December 23. This was accompanied with the passing of the Federal Reserve Act, a reaction to a sequence of financial threats, predominantly, a deadly economic threat in 1907. The responsibilities and roles of the Federal Reserve System have enlarged, and its structure has progressed. Issues, for example, the Great Depression, led to advancements in the Federal Reserve System (Broz, 1997). The congress set up three significant objectives or goals for monetary policy in the Federal Reserve Act. They include highest employment, steady prices, and sensible, long term interest rates. The first two objectives; highest employment, steady prices can be termed as the dual mandate of the Federal Reserve. Nonetheless, over the years, the functions of the Federal Reserve System have grown. The official Federal Reserve records show the Federal Reserve System duties include regulating and supervising banking institutions, handling the country’s monetary policy, offering financial services to the United States government, foreign official organizations, and depository institutions, and managing the stability of the financial system (Broz, 1997). In addition, the Federal Reserve System carries out investigations of the economy and produces several publications, for example, the Beige Book. It contains a decentralized structure. This structure constitutes the Federal Reserve Board or Board of Governors appointed by the president, Federal Open Market Committee, Federal Reserve Banks in twelve regions found in the country’s key cities, several advisory councils, and a number of private America member banks. Federal Open Market Committee is charged with the mandate of establishing monetary policy and is made up of seven associates of the twelve regional banks presidents and Board of Governors. Nevertheless, only five presidents from the regional banks can cast their vote at one time. The Federal Reserve System contains both public and private elements (Hafer, 2005). The Federal Reserve System was established to fulfill the concerns of both the public and bankers in the private sector. This results in a structure that is distinctive with the central banks. The structure of the Federal Reserve System is also unique because, the Treasury, a body external to the central bank develops the currency utilized in the economy. The Board of Governors asserts that the Federal Reserve System is an autonomous central bank. This is because the System’s monetary policy judgments do not have to be permitted by the head of state or a person in the legislative or executive branches of government (Hafer, 2005). Moreover, the Federal Reserve System does not get finances passed by Congress. Also, the provisions of the Board of Governors members last numerous congressional and presidential terms. Additionally, the authority of the Federal Reserve System is obtained from statutes passed by the Congress and the System is focus to oversight by Congress. The president chooses the members of the Board of Governors, including the chairperson and vice chairperson, and then they are verified by the Senate. In addition, the government practices control over the Federal Reserve. They do this by employing and regulating the payments of the high level employees of the Federal Reserve System. Also, nationally chartered commercial banks are necessitated to have stocks in their region’s Federal Reserve Bank. This allows them to choose members of the regional Federal Reserve Bank. This shows that the Federal Reserve System contains both private and public elements. The decentralized structure of the Federal Reserve System increases its autonomy. This permits the Federal Reserve System to chase its objectives without political interference that may not suit the interest of the economy of the country. Moreover, this structure increases the Federal Reserve System’s transparency and allows citizens to make their contributions or voice their opinions (Hafer, 2005). The Federal Reserve System cannot influence employment and output or manage inflation in a direct way. In its place, the Federal Reserve System impacts them indirectly by lowering or raising the short term interest rate. Often, it accomplishes this by open markets activities in the market banks for bank reserves. This is referred to as the federal funds market. Reserve requirements entail depository institution and banks storing an amount of money in reserve to accommodate unexpected loss. Banks can store these reserves in the form of deposits with the Federal Reserve System or as cash in their vaults. The banks should store funds in their reserves every time. Moreover, the Federal Reserve System employs the market operations to influence the supply of reserves in the banking structure (Hafer, 2005). The Federal Reserve System sells and purchases government collaterals on the open market. For example, if the Federal Reserve System wants a drop of the funds rate to occur, it purchases government collaterals from a bank. The Federal Reserve makes payments for the securities by multiplying the reserves of the bank. The result is that the bank will have additional reserves. The bank can loan the additional reserves to other banks or financial institutions in the market. When the Federal Reserve System wants the finance rates to increase, it sells government collaterals. The Federal Reserve System gets sums from banks. This decreases the reserves supply in the banking system, and the financial rates escalate. Moral suasion is an influence technique used to pressure and influence banks comply with policy (Hafer, 2005). Techniques utilized include vague threats, closed door meetings with directors of banks, appeals to community spirits, and enhanced severity of inspections. An example, of moral suasion is the chairman of the Federal Reserve System talking about the markets. His views on the economic situation can make financial markets fly or fall. Discount rate refers to the interest rate utilized to establish the current price of future cash flows. The discount rate considers the uncertainty or risk of the probable future cash flows and the period worth of money. The Reserve Banks’ Board of Directors set the rates. Nonetheless, these rates are determined and reviewed by the Federal Reserve Board. Putting the discount rate elevated than the funds rate is meant to deter banks from going to the source before they use alternative less costly means (Hafer, 2005). In addition, the relatively effortless accessibility of reserves at this rate adequately sets a maximum amount on the rates of funds. The Federal Reserve System has a role in meeting the economy’s objective on unemployment. The unemployment rate for every key demographic faction lessened in the month of September. There was a decrease in the unemployment rate for whites, adult men, and adult women in the month of September. There was also a small change in the unemployment rates for Hispanics, teenagers, and blacks and the unemployment rate for Asians dropped over the year. The Federal Reserve System can use moral suasion to reduce the rate of unemployment. The Federal Reserve Board can pressure and influence banks comply with policy (Lita & Preston, 2003). They can advise the banks to change the style it utilizes to communicate probable future interest rate or decrease interest rates. For example, the Federal Reserve System may assert that the main interest rate should be close to zero for a prolonged time than the current communication. For example, reducing the interest rates reduces the borrowing cost to purchase commodities. As purchases increases, companies need to produce more commodities, hence the need to employ additional workers. This reduces the unemployment rate. The Federal Reserve has a role to meet the inflation goal. It has been argued that sensible inflation assists advance stable financial markets, economic growth, and employment. Inflation is perceived as allowing product and labor markets operate easily in the presence of shock that may decrease output or employment. The Federal Reserve may employ the federal funds market to control inflation. The Federal Reserve does this by controlling credit. The Federal Reserve can manage credit by making credits more expensive and increasing the interest rates. These measures help lessen the supply of money, and in turn, deal with inflation. Curbing inflation is essential because it allows for benefits of economic growth (Lita & Preston, 2003). In contrast, the Federal Reserve makes credit inexpensive by reducing interest rates when there is no threat of inflation. This helps facilitate business growth, enhance liquidity, and subsequently decreases unemployment. The Federal Reserve System also has a role in addressing economic growth. The economic performance of the country is influenced by a number of factors. They include monetary policy implemented by the Federal Reserve, external economic performance, and fiscal policy set by the executive and legislature. The key role of the Federal Reserve System is to apply proper monetary policy to keep the economy growing. The Federal Reserve System may employ the reserve requirements tools to meet the goals of economy on economic growth. This tool entails banks storing an amount of money in reserve to accommodate unexpected loss. In case of inflation, which causes a decrease in economic activities, the banks can use the money in their reserves to support the economy (Lita & Preston, 2003). This will help to restore the country’s economy and promote economic growth. This money may be used to carry out business activities that will enhance the growth of the economy. The Federal Reserve System is also involved in the current economic environment. The Federal Reserve System functions with a double authorization to promote price stability and maximum employment in the economy. It also functions as lender of last resort to the banking sector. Sustaining stable and low inflation are essential to attaining the largest rate of economic growth and maximum employment. Moreover, price stability tends to increase the central bank’s capacity to react to financial issues that appear and encourage financial stability. In addition, the Federal Reserve System collects economic information from all sectors as a component of the process of setting monetary policy (Lita & Preston, 2003). The information constitutes the consequences of monetary policy on the several areas and economic situations. The sketchy information is relevant in assessing economic situations in the whole country. How correct the Federal Reserve System assesses the economy and develops laws to influence that path tremendously effects the employment and economic situation of Americans. In my opinion, in the next 12 to 24 months, the chairman of the Federal Reserve System should maintain price stability and support the economic recovery (Hafer, 2005). This may be achieved by maintaining both long term and short term rates at a minimal. Minimal interest rates decrease the cost of cars, homes and other consumer goods while enhancing the appeal of fresh firms’ capital investments. In addition, an increased demand in commodities will promote additional employment opportunities and quick growth of the economy. Economic stimulus refers to efforts to utilize fiscal or monetary policy to accelerate economic activities. It can also entail monetary policy, for example, decreasing interest rates. There are several economic stimuli, and they operate in different modes. Tax cuts for people promote short term spending. Tax cuts for firms promote both investment and spending (Lita & Preston, 2003). In 2009, the Federal Reserve System had decreased rates to almost zero. This was a way the administration sought to advance the economy. This plan intended to give a large number of Americans tax cuts and create or save over three million jobs in the short term. The plan also intended to accelerate key areas of the economy, for example, health care and energy, making American companies internationally competitive in the long term. The Federal Reserve and treasury have also undertaken traditional and non-traditional measures to ease and support credit or financial markets. The Federal Reserve has employed traditional monetary policy techniques at the macroeconomic stage, and the market level to give extra liquidity. The Federal Reserve employs discount window tools and open market operations by enlarging qualified borrowers, terms of transactions, and form of collateral. The Federal Reserve has also utilized non-traditional measures, for instance, the Term Deposit Facility. The Term Deposit Facility permits Reserve Banks to provide term deposits to organizations entitled to get payments on their Reserve Banks’ balances. Term deposits aim to aid the realization of monetary policy by granting a tool the Federal Reserve can control the collective quantity of reserve balances stored by depository organizations. Finances stored in term deposits are taken out of the participating organizations’ accounts for the term deposit’s existence and thus exhaust reserve balances from the banking scheme (Hafer, 2005). References Broz, J. L. (1997). The international origins of the Federal Reserve System. New York: Cornell University Press. Hafer, R. W. (2005). The Federal Reserve System: An encyclopedia. Connecticut: Greenwood Press. Lita, E., & Preston, M. (2003). The complete idiots guide to the Federal Reserve. New York: Alpha Books. Read More