Federal Reserve: iInflation - Essay Example

It also acts as the bank's bank, meaning that the Fed is the lender of last resort to banks that need to borrow money to maintain stability. Fed's second and most important task is to control money supply. A special committee at the Fed Reserve - the Federal Open Market Committee - directs the US monetary policy. Natural disasters cause inflation. This is so, because natural disasters, such as hurricanes or earthquakes cause losses that reduce real variables, such as physical products or property.

This increases the demand for these variables, because people need to restore the physical losses. Higher demand and decreased output has the effect of increasing price levels and people have to pay more dollars the same quantity of goods and services. For example, after Hurricane Katrina, and Hurricane Rita energy prices increased significantly (Olson, 2005), because of limited supply and increased demand for gas and petroleum products. Higher gasoline, natural gas and petroleum products prices led to increased costs of other goods and services, such as transportation and building materials.

Higher price levels reflected in a higher inflation rate. The Fed is run by a Board of seven governors appointed by the President and confirmed by the Senate (p. 634). Each of the governors has a 14-year long term which gives them greater independence from political pressures in directing US monetary policy. The key person in the board, and probably the second most powerful person in US (p. 635), is the Chairman who has a four-year term. The Chairman manages the staff of the Federal Reserve, presides over board meetings, and is responsible for Fed's policy in front of congressional committees.

Since January 1, 2006 the new Chairman of the Board of Governors is Dr. Ben Bernanke, a successor to Alan Greenspan (Federal Reserve).4. Do voters have a say in the implementation of monetary policy The Fed's control over money supply is indirect (p. 639), because all of its actions are reflected in the banking system. Banks and voters play an important role in the monetary system, because peoples' checking accounts are held in banks and thus influence the money supply. The Fed does not control the amount of money people and households choose to hold as deposits in their banks (p. 640). When households have trust in the banking system, they hold more money as bank deposits, banks have more reserves, hence the banking system can create more money and vice versa.

People's expectations about the future also affect the implementation of the monetary policy. For example high inflation expectations may reflect lower level of public confidence in policy makers (Piger, 2005). If the public believes policy makers are not credible in their goals, it will have higher inflation expectations for the future. These expectations are likely to affect present behavior and are expected to actually impact inflation rates. 5. How is inflation measured The increase of the overall price level is called inflation (p. 645). One way of measuring inflation is by indexes that reflect changes in price levels over time.

One measure of the price level is the Consumer Price Index (CPI), which measures the