The Central Bank of United States: Federal Reserve Bank - Essay Example

History of FED
The early history of banking in the United States suggests that during its nascent stage, Banking runs were common as many banks opened and faltered during a small period of time. Based on the increasing failures of financial institutions, Congress set up National Monetary Commission to look into it. The commission presented its first monetary reform plan to Congress in the year 1912. This plan recommended the establishment of the National Reservations Association which would hold the reserves of commercial banks and could make short-term loans to banks to ensure credit availability. United States Congress responded to the situation by enacting Federal Reserves Act thus creating Federal Reserve System. President Woodrow Wilson endorsed these recommendations and Federal Reserves Act became law on Dec 23, 1913, and FED was created (Federal Reserve Bank of Dallas).

The primary responsibility of the FED is to manage enough money supply and credit to sustain the economic growth of the country by containing inflation.

The contraction and expansion of the economy are thus achieved with the help of the following two economic variables:
1) Money Supply: Expanding or contracting the economy through the money supply is the most frequent method used by FED to exercise its powers to make changes in the economy. Traditionally called Open market operations, these are the activities through which FED either purchase or mope up the excess liquidity from the economic system by issuing securities called T-Bills or Treasury Bills. Similarly, when FED wants to expand the economy through money supply, it will purchase the issued T-Bills thus offloading hard currency in the market. This is done primarily for one purpose and that is that through this, FED wants to control the flow of money in the economy. The easy availability of excess money may create inflation in the economy hence have the potential to impact the real growth in the economy.

2) Interest rates: FED controls the expansion or contraction in the economy through interest rates effectively in two ways. One is through making changes in the discount rate and the other is through increasing or decreasing the interest rates on T-Bills to be issued by FED. The discount rate is the interest rate at which banks can borrow from the FED in case they require short-term funding. By raising or decreasing the discount rate, FED basically makes borrowing more costly or less cheap hence restricting or expanding the flow of credit in the economy.

Conclusion
FED is one of the largest central banks in the world with the primary mandate of managing the economy of the United States by regulating monetary policy. The regulation of the monetary policy is done mostly through two methods of money supply and interest rates.