Federal Reserve System - Essay Example

FEDERAL RESERVE Federal Reserve System or Federal Reserve is the US central system of banking which has evolved over time to include a number of duties as against the three main responsibilities that it was initially charged with. These responsibilities are ensuring maximum levels of employment within the country, stabilizing the prices as well as ensuring that long-term rates of interests are moderated within the country (Bartel, 1996). Nevertheless, these responsibilities have increased over years to include the conduction of monetary policy to the country, regulation and supervision of banking institutions within the country, stabilizing the country’s financial system and carrying out strategic economic researches within then economy. It is to be noted that the Fed is unique in that it has no external influence from the executive and or the presidency and hence has very independent monetary policies. The role and the effectiveness of the Federal Reserve in stabilizing the current economy In among other current responsibilities that the Fed undertakes currently is ensuring the stability of the economy as it is today. According to the fed website, it is currently charged with the responsibility of ensuring and promoting economic growth, revitalizing employment, stabilizing prices as well as ensuring stability of interest rates. This therefore implies that the Fed ensures that the economy of US is stable and healthy while at the same time improving on the banking system(s). It thus takes an active role in making decisions over monetary policies over which the economy realizes stabilized employment levels, stabilizes prices as well as inertest rates for the welfare of the economy. Moreover, in regulatory practices, the Fed ensures that consumers in the economy safeguard credit rights of consumers through regulating the banks and ensuring that they are safe for operations. In ensuring that the current economy is stable, the Fed undertakes a number of duties among which is conducting thorough and periodic research studies on the economy and availing the findings even to the public. The essence of the studies is to make available useful; information to the public on the performance of the economy at any one time which would be necessary in decision making on economic matters. Besides, the Fed is expected to make monetary policy decisions as are necessary to maintain then economy in the right track of growth, which is only possible through the regulation of interest rates as well as ensuring efficient flow of money in the economy. For instance, in ensuring improved economic performance with effectiveness in money supply, the Fed increases the supply of money to banking institutions, which in turn, through effective policies increases the lending to the customers. Another tool is through lowering rates of interests to banks and financial institutions which increases the rates of borrowing by these institutions and which is reciprocated with increased borrowing by the public. The interest rates that the Fed designs and adopts towards other financial institutions within the country would be termed as the discount rates. On the other hand, in order to increase the financial supply within the economy, the Fed responds by lowering the bank reserves where tactics are employed to have the financial institutions increase in lending rates thereby increasing the money in circulation within the economy. Buying from the public the government securities as well as treasury bonds is another such effective tool that Fed employs in increasing money in supply as would be necessary in ensuring the economy is stable. This is quantitative easing which works through boosting the money in circulation, which increases consumer spending for the betterment of the economy in growth. Nevertheless, there are instances when the economy would be growing fast and the Fed is responsible of slowing the pace down. It is therefore obliged to employ the reversal measures of what boosting the economy employed. For instance, it increases the interest rate borrowing institutions, which have the effecter of keeping much money with the banks and hence reducing the lending rates. Besides the rich endowment in form of assets by the Fed, it makes its money through open market operations such as through sale of securities as well as interest returns from institutions of finances. Financial services like the electronic payment cards as well as cheques contribute to the great reserves that the Fed has. Besides, interest by foreign deposits with the Fed raises income to the institution through accrued interests. It is therefore to be acknowledged that the Federal Reserve has been very effective in stabilizing the current economy as is shown through the above tools as discussed. However, the effects of global shocks and the crises as was experienced from 2008 has had a great impact and critics would therefore arise and criticize the effectiveness of the body in ensuring the economy stability of US. Economic indicators the Federal Reserve should analyze so it can better stabilize this particular economy Inflation: The Fed is charged with the responsibility of ensuring economic stability through stability in the money in circulation and therefore the analysis of economic stability through inflation is therefore a critical aspect that the Fed should do. The levels of inflation explain the lack of or availability of excess funds in circulation within the economy. Whenever the Fed establishes that much money is in circulation, then measures for contraction are used effectively in lowering the amount of money circulating. Such measures as would be appropriate for lowering the amounts of money circulating is through open market operations and raising the interests by lending institutions as necessitated by policy formulations by the Fed. Reserve requirement: Fed sets out the reserve requirements to the lending institutions in the economy, which outlines the main amount in percentages that banks are, required to hold at any particular instance. By analyzing the position of banks and such financial institutions, the Fed is in a position to adopt monetary policies as would be effective in raising and lowering the rates of borrowing in order to influence the finances in circulation. Market operations: ‘Open market operations’ include the operations where Fed does particular transactions to influence the amounts of money in circulation within the economy. The Fed therefore has a direct responsibility in studying the trends in open market operations to develop and implement most appropriate policy guidelines as would be necessary to stabilize the economy at large. Fed funds: Banks and such other lending institutions borrow these finances from their counterparts whenever they run short of sufficient lending finances. The Fed predetermines interests accorded to such borrowings and hence the essence of studying and analyzing the prevailing fed funds, which equally contributes towards stabilization of the economy. Monetary policies the Federal Reserve might use to influence the money supply Money supply within the US economy is done by the Fed through imposing effective monetary policies which among other things they establish a stable financial infrastructure within the economy. Among the policies that Fed would employ in the efforts to influence the supply of money are policies meant to influence the rates of interest financial lending institutions apply to borrowers and this would have direct implications on the money available/circulating in the economy. Among these policies are expansionary policies, which are meant to ensure that there is increased currency in circulation within the economy; for instance, the Fed would participate in ‘open market operations’ through buying of public bonds. Through such buying, more finances are injected into the economy and this increases the finances in circulation, which are necessary for economic growth. Through increased currency in circulation, the public is made to increase in spending hence contributing towards the growth of the economy. On the other hand, the Fed may decide to employ measures with contractionary effects where it would sell more of the bonds and securities to the public. Through these measures, the public has little left to spend and hence leads to lowered economic activity (Woodford, 2002). Other tools that would be applied in monetary policies are interest rates variation where in the instance that Fed is interested in encouraging higher borrowing by public and the financial institutions, lowering rates of interest works extemporary well. In contrast, when the Fed would be interested in controlling higher borrowing by public and the lending institutions, then rates of interests are increased which results to lower borrowing. Besides, it would also use the federal reserve’s which regulates the requirement of all financial institutions to hold to some basic reserves in percentage form in order to control over-lending to the public. These are all useful tools that have been used and can be used by Fed in controlling money in circulation within the economy and would be better termed as the monetary policies. Strengths and weaknesses of using monetary policy in comparison to fiscal policy when promoting economic activity and preserving price stability Whereas the regulation of interest rates within an economy explains monetary policy, the fiscal policy is the use of taxation as well as the government expenditure in influencing the economy. In the process of influencing an economy’s performance through promotion of economic activity as well as through preserving the stability of prices within a country, the two main tools applied are the fiscal policies (by government) and the monetary policy as employed by Fed. There are however, distinct advantages and disadvantages that arise in using monetary policies in ensuring improved economic performance while compared with the fiscal policy (Thorbecke, 2002). Strengths: stable prices arise because of the mechanisms discussed on regulation of effects on by the Fed through influencing the purchasing power of finances in the economy. For instance, when inflationary pressure is on the rise, Fed may opt to sell securities in order to reduce money in circulation and this ensures that products carry stable prices. Moreover, the monetary policy attracts strength in ensuring long term growth and control of inflation is realized. Weaknesses: low levels of inflation as well as sustainability in economic growth often results to conflicting goals in monetary policy. This therefore points towards the ineffectiveness of Fed in employing the tool for the welfare of the economy and price stability. Moreover, time lags or delays are characteristic features of the monetary policies, which the Fed employs hence the weakness of realizing the intended results after long durations of time. Effect of the Federal Reserve’s action you identified in #3 on the aggregate demand / supply model An aggregate demand and supply model depicts the prevailing market performance in an economy. Fed’s actions in monetary policies meant to cause expansionary effects increase both supply and demand and as such shifts the equilibrium to the right. The reverse is true where when Fed employs contractionary monetary policies, the demand is lowered as well as the supply and hence the overall equilibrium level shifts to the left. When the analysis involves effect of monetary policies in the interest rates, increased rates implies low levels of borrowing and lending hence reduced levels of money in circulation. However, when the rates are lowered, this creates an incentive where higher rates of borrowing are realized thereby resulting to increased money in circulation. Higher spending results in demand/supply increases causing the shift of equilibrium to be to the right (Campbell et al, 2012; Dunkelberg & Scott, 2009). Conclusion These effects are therefore perceived as most effective measures upon which the general performance of an economy would be assessed. This paper therefore takes a special focus in analyzing the Federal Reserve and its role in the US economy currently. Though the global economy faces strategic spells of contraction and expansion and general cases of economic instability, the US economy is seen to ride rather stably than many of global players. This paper has analyzed the functions of the Fed with special attention to policies and efforts on economic stability. Among other findings is that the organization has had tremendous success in the management of these affairs especially in the modern times. Much of the success would be attributed to improved policy formulation especially regarding regulation of rates of interests, ensuring improved employment rates as well as ensuring general flow of money in the economy. References Bartel, R. D. (1996). Federal reserve independence and the peoples quest for full employment and price stability. Journal of Post Keynesian Economics, 18(2), 231. Campbell, J. R. et al, (2012). Macroeconomic effects of Federal Reserve forward Guidance/Comments and discussion. Brookings Papers on Economic Activity, , 1-80. Dunkelberg, W. C., & Scott, J. A. (2009). The response of small business owners to changes in monetary policy. Business Economics, 44(1), 23-37. Thorbecke, W. (2002). A dual mandate for the federal reserve: The pursuit of price stability and full employment. Eastern Economic Journal, 28(2), 255-268. Woodford, M. (2002). Financial market efficiency and the effectiveness of monetary policy. Economic Policy Review - Federal Reserve Bank of New York, 8(1), 85-94 Read More