Role and Effectiveness of the Federal Reserve in Stabilising Current Economic Conditions - Essay Example

The Federal Reserve Introduction The ‘Federal Reserve Board’ (FRB) along with their functions together forms the ‘Federal Reserve System’(FRS), which is also acknowledged as the ‘Federal Reserve’ or ‘the Fed’. It is basically an incorporated structure comprising ‘12 Federal branch banks’, ‘all national banks’, ‘ state-chartered commercial banks’ and a handful of ‘non-profit organizations’. The FRS got enacted in the year 1913 by President ‘Woodrow Wilson’. This system was started by the Congress government with the intention of providing safety to the country in the context of elastic and steady financial system. Moreover, the system aims at controlling the economy of the United States by regulating short-term interest charges and supply of funds. All the policies, reports and publications issued by this system are formulated under the supervision of the federal board members (Board of Governors of the Federal Reserve System, 2014). The focus of this essay will be towards determining how FRS provides a thorough evaluation of existing ‘economic activities’, ‘financial markets’, and ‘monetary policy tools’ that are used for promoting economic activity and preserving stability in the pricing levels in the US. Various significant aspects that include the role along with the effectiveness of Fed, analysis of the economic indicators, effect of the actions of Fed upon aggregate demand and strengths along with weaknesses of using monetary policies as compared to fiscal policies will be discussed in the essay. Role and Effectiveness of the Federal Reserve in Stabilising Current Economic Conditions The role along with the effectiveness of the Fed in stabilising the current economy can be better understood with the help of the following aspects. The FRS system focuses towards projecting a transparent picture of the nation’s economic conditions through proper analysis of money circulation policy in terms of employment as well as price stability. These data provides support during future monetary policy formulation. Moreover, FRS also supervises and regulates multiple banks and other financial organisations in order to maintain a sound functionality and safeguard the credit rights of the customers. Besides FRS maintains stability of the financial system and helps in repression of systemic risks frequently occurring in the financial markets through developing effective fiscal policies and monitoring their implementation. In addition, FRS provides quality monetary services specifically to the ‘U.S. government’, ‘U.S. financial institutions’, and other ‘foreign official institutions’. It also plays a decisive role in supervising and regulating the country’s payment systems (Board of Governors of the Federal Reserve System, 2014). Analysis of the Economic Indicators for Stabilising the Current Economy The Fed should analyse numerous economic indicators for better stabilising the current economic condition of the US. These financial indicators have been described in detail in the following section. The first economic indicator, which must analyse by the Fed for stabilising the current position of the US, is the ‘Real Gross Domestic Product’ (GDP). This indicator projects the market price of all sorts of goods or services that produce by a nation during a specific period. It helps in determining the financial position of a nation in terms of projecting the rate of profit growth and the anticipated capital return (Redfield, Blonsky & Co, n.d.). The reason for it being stated as “real” because the financial data of each and every year is taken into concern for making necessary adjustments in order to determine year to year change in prices. The real GDP indicator is a broad way of estimating the health and the interests of a particular economy. The data, which would be obtained from this real indicator must utilise by the Fed for making further improvements in its monetary policies (Redfield, Blonsky & Co, n.d.). The second essential economic indicator, which must analyse by the Fed for stabilising the current economic position of the US, is the ‘M2 Money Supply’. This indicator projects the sum total of all sort of circulating funds in a country’s economy. These circulating funds generally includes ‘bills’, ‘traveler’s checks’, ‘coins’, ‘demand deposit savings accounts’, ‘checking accounts’, ‘individual time deposits’, ‘savings deposits’, ‘repurchase agreements’ and ‘Eurodollar holdings’ (Redfield, Blonsky & Co, n.d.). The Fed should utilise the data extracted from the ‘M2 Money System’ for evaluating the present monetary and economic circumstances prevailing in the US economy. Understanding from these data would certainly help the Fed in making alteration in its various monetary policies. These policies are often framed for regulating the increase as well as the decrease in the interest rates. Evidently, multiple economists also utilise M2 indicator data for predicting economic recessions and stock price variation (Redfield, Blonsky & Co, n.d.). The third essential economic indicator, which must use by the Fed for stabilising the current economic position of the US, is the ‘Consumer Price Index’ (CPI). This describes the variation in the prices of goods or services that are paid by the urban customers for a specific month. It is worth mentioning that Fed should rely upon this specific indicator specifically for measuring inflation levels. Generally, the data of this indicator is mainly issued every month by the ‘Bureau of Labor Statistics’, which is a part of the ‘U.S. Department of Labor’ (Redfield, Blonsky & Co, n.d.). The fourth financial indicator, which must take into concern by the Fed for stabilising the current position of the US economy, is the ‘Producer Price Index’ (PPI). This is viewed as a combination of multiple indexes that determine the variation in the selling price of the goods or services, which witnessed by the U.S. producers over a specific period (Redfield, Blonsky & Co, n.d.). The fifth essential economic indicator is the ‘Beige Book’, which describes the economic condition of every federal region. It is a part of the ‘Federal Open Market Committee’. This economic indicator would aid the Fed in stabilising the current US economic position through making amendments in their policy-making procedures relating to finance and other related aspects (Redfield, Blonsky & Co, n.d.). Apart from the above discussed economic indicators, certain other economic indicators that must analyse by the Fed are Current Employment Statistics’ (CES), ‘Retail Trade Sales’, ‘Food Services Sales’, Housing Start’, ‘Manufacturing and Trade Inventories and Sale’, ‘S&P 500 Stock Index’, and ‘Consumer Confidence Survey’ (CCS). All these indicators together provide statistical data about the existing economic scenario, aiding the Fed towards making effective changes in its various monetary policies (Redfield, Blonsky & Co, n.d.). Types of Monetary Policies used by FRS for influencing Money Supply As per the above analysis, it can be affirmed from a broader understanding that the Fed usually controls money supply through the use of monetary policies. These monetary policies can be segregated into two categories. The first one is the ‘expansionary monetary policy’ and the second one is the ‘contractionary monetary policy’. These two monetary policies might use by the Fed in influencing the money supply, which would result in controlling the economy at large (SparkNotes LLC, 2014). Conceptually, the expansionary monetary policy mainly focuses towards expanding the economy and increasing the level of output. On the other hand, in the case of contractionary monetary policy, economy shrinks and most vitally output decreases (SparkNotes LLC, 2014). The other monetary policy, which might use by the Fed in influencing the money supply is bringing or introducing changes in the ‘reserve requirements’. This can be justified with reference to the fact that decrease in the reserve requirement would eventually force the banks in keeping hold of certain portion of the reserve and making the remaining portion to be available as loan. This result in significant increase in the money supply and for a specific initial deposit, a smaller reserve requirement will be provided (SparkNotes LLC, 2014). The third monetary policy through which the Fed can regulate as well as influence the money supply is through bringing about variations in the interest charges of the federal funds. Specially mentioning, increase in the federal fund rates, the banks will turn up from borrowing funds from the Fed and supply fewer loans to the customers in order to meet up their minimum requirements. The opposite happens with the decrease in the federal fund rates for supplying money to the economy (SparkNotes LLC, 2014). Strengths and Weaknesses of Using Monetary Policy in Comparison with Fiscal Policy One of the major strengths of using monetary policy as compared to fiscal policy especially at the time when promoting economic activity and preserving price stability is that the operating pace of monetary policy is much faster and supple as compared to fiscal policy. Through the use of monetary policy, the Fed can make the transaction i.e. purchasing and selling of securities on regular basis. Adding to that, the monetary policy can be viewed not too much related with politics as compared to fiscal policy and therefore can easily respond to economic changes. Moreover, it has been apparently observed that the changes in the monetary policy are much more delicate and are not under intense observation in comparison with the changes in fiscal policy. In terms of weaknesses, excessive government spending in fiscal policy results in massive rise in inflation level, which is quite hard to control through increasing tax rates. In such case, monetary policy proves to be an effective tool in creating inflation and recession through effective tax rate regulations as compared to that of fiscal policy. The other major weakness of using monetary policy instead of fiscal policy is that it is quite time consuming in making any sort of change relating to the aspect (Montor & et al., n. d.). Effect of Federal Reserve’s Action on the Aggregate Demand / Supply Model It would be vital to mention that as the Fed mainly uses both fiscal and monetary policies for controlling the economic functionality, these two policies might impose certain significant impact on the aggregated demand or supply model at large. Specially mentioning, the effect of the actions of the Fed specifically on the aggregate demand or the supply model can be determined in two ways. The first way depicts augmentation in the direct demand level by continuous governmental purchases at constant tax rates. The second way portrays lessening tax rates by the government, which in turn increase the households’ disposable income and level of spending on consumption. This results in raising the level of aggregated demand (Montor & et al., n. d.). During economic recessions or financial booms, there often occurs incessant fluctuations in the aggregate demand levels, but no such effects can be seen on the production capability of the economy (Weil, 2008). In this regard, monetary policy mainly aims at balancing such fluctuations. As for the aggregate supply part is concerned, it has been apparently observed that a weak aggregate demand can hamper an aggregate supply through certain multifactor production aspects (Weil, 2008). It can be affirmed that the role of the Fed’s action on aggregate supply model is quite significant as it determines the relationship existing between output quantities and pricing levels. It shows positive response in short-run perspective in terms of price level and demand but those changes in the long-run scenario (Mankiw, 2014, pp. 503-504). Adding to that, the regulation of the fiscal and the monetary policy by the Fed can certainly help in determining the increasing level or decreasing the level of aggregate supply. When the Fed tends to drive in money into the economy by tax reduction and through provision of subsidies, the demand substantially elevates as the percentage of household disposable funds increases along with production and supply. Similarly, in the opposite case, when the Fed desires to drive out money through raising taxes and cancelation of subsidies, the demand substantially decreases similar to aggregate supply (Mankiw, 2014, pp. 503-504). Conclusion From the above analysis and discussion, it can be comprehended that the Fed along with its various roles play imperative role in promoting economic activities and maintaining stability in price levels by a considerable extent. Careful regulation of the fiscal along with monetary policy by the Fed significantly helps in maintaining a steady flow of economy through prevention of excessive inflation and recession. It also helps in preventing the economy from entering into a state of financial crisis. References Board of Governors of the Federal Reserve System. (2014). What is the purpose of the Federal Reserve System? Retrieved from http://www.federalreserve.gov/faqs/about_12594.htm Montor, C., Takats, E., & Yetma, J. (n. d.). Is monetary policy constrained by fiscal policy? Retrieved from http://www.bis.org/publ/bppdf/bispap67b_rh.pdf Mankiw, N. (2014). Essentials of economics. Boston: Cengage Learning. Redfield, Blonsky & Co. (n. d.). The top 10 economic indicators. Retrieved from http://www.rbcpa.com/economic_fundamentals.pdf SparkNotes LLC. (2014). Tax and fiscal policy. Retrieved from http://www.sparknotes.com/economics/macro/taxandfiscalpolicy/section2.rhtml Weil, D. N. (2008). Fiscal policy. Retrieved from http://www.econlib.org/library/Enc/FiscalPolicy.html Read More