Federal Reserve System - Essay Example

Federal Reserve Policies of central bank of a country with respect to money supply are generally known as monetary policy. Monetary policy could be well understood from its primary objective that is, stabilizing price level in the economy. The phenomena of price rise is largely because output cannot be adjusted to demand in the short run; wherein there would be more money chasing too few goods. This can be better understood in the framework of quantity theory of money, which is expressed as M * V = P * Q where M is money supply; V is the velocity of money; P is price level and Q is output. The V and Q are fixed so that any change in M causes a proportionate change in P. To control P, it is therefore necessary that M be brought under control. Any policy with respect to this is known as monetary policy. Amongst various instruments available with central bank are interest rates, reserve requirements, interventions in the credit market and so on. These instruments are used to influence the demand for liquidity and, thus, M could be controlled. Federal Reserve is performing the function of central banks in the United States. Its policies are popuraly known as monetary policy of the country. In fact, Federal Reserve uses several policy instruments to reduce the adverse effects of fluctuations in income. An important instrument used to influence money supply is interest rate, which is signaled by Federal Rate. In the transaction motive for money, there is an inverse relationship between opportunity cost of money that is interest rate and demand for liquidity. As such, if Federal targets inflation, it would have to increase interest rate so that liquidity is removed from the system. Any increase in interest rate would induce people to part away liquidity and thereby bring about stability in the price level. Second mechanism operates through credit market. It is assumed that borrowing from credit market finances entire investment spending. Credit expansion is an important mechanism for money creation; thus, if credit expansion is controlled, money supply can be controlled and so price could be controlled. Federal could use interest rate directly to influence credit creation. A necessary and sufficient condition for investment to take place is that marginal efficiency of capital, measured by rate of return, should be at least or equal to cost of capital, given by interest rate. With every increase in Federal rate, the Federal Reserve indirectly increases cost of capital such that the basic condition for investment spending gets violated. This reduces incentives for private investment resulting is lack demand for credit. Similarly, if the economy has slowed down, they could reduce interest rates and thus provide stimulus for investment spending. Thus, monetary policy could be used to smoothen the business cycles by the Federal Reserve. Consider the situation of economic slowdown witnessed by the United States from the third quarter of 2008 with the surfacing of sub-prime crisis. In such situation, government follows expansionary policies, which is normally associated with its fiscal policy. For instance, the announcement of fiscal stimulus package amounting to $785 billion in January 2009. In standard Keynesian income determination model, there are two important variables, namely, autonomous spending and multiplier, which are considered as major determinants of income and hence economic growth. Autonomous spending refers to all spending which are independent of income and government spending is one of them. Targeting the growth, government could increase or reduce their purchases of goods and services in the economy, or by transfer payments. The multiplier is the multiple of a unit change in income due to a unit change in autonomous spending. Larger the multiplier, larger would be the change in income. In order to improve effective demand in the economy, government could resort to any of these options. If they target shifting aggregate demand curve, they would pursue expansionary policies such as spending more on purchases of goods and services. Depending upon the perception of the rate of unemployment, the government could formulate polices so as to bring the rate of unemployment level to a desirable level. However, increased government spending would result in fiscal deficit and government would require more finances which has to be met by central banks. Since government’s demand has to be met by either by printing currency or by mopping liquidity from the system, it is not considered desirable. When central banks have to print currency to meet government deficit, it injects additional liquidity in the system. Since output in the short run cannot be increased, additional liquidity in the system is likely to land in inflationary situation, which militates against underlying objective of monetary policy. This is a vital issue that Federal Reserve cannot simply shy away. Thus, Federal Reserve often faces a dilemma. While it has to frame growth inducing policies like reducing Federal rate that may eventually boost up private investment and consumption spending, it has to also ensure that inflation rate does not rise. It is this policy dilemma, which forces the Federal Reserve to make a conscious tradeoff between growth and inflation. When the economy does not perform well, its policies has to compliment fiscal policies, through it may be inflationary in nature. More often than not, Federal Reserve is headed by professionals (read as economists) and so they also become obvious targets for criticisms. What gets ignored is that unless they make such trade off, they would not be able to support expansionary fiscal policies. References Abel, A.B and Bernanke, B.S. Macroeconomics. New Jersey: Pearson Education Inc. 2001 Globalization Globalization in economic context is integrating goods, labour and capital market. Under globalization, there is a high degree of internationalization of economic activities covering manufacturing, off shoring of services and so on. With the removal of barriers to trade and restrictions on mobility of factors of productions, capital would become highly mobile between countries and get located in those economies where other factor cost found cheaper, and resources could be easily accessed. Given the fact that globalization reduces barriers, it provides umpteen opportunities for countries to take benefits of markets across the border. If a country has comparative advantage in producing any commodity, it is likely to find a new market beyond its border. This newly found market provides additional source of demand for its products and services, and thus enables everyone to achieve economic prosperity. The notable growth reported by two fastest economies such as China and India provides evidences as to how countries could get economic benefits due to increased integration with global economy. Experience of these two countries clearly brings out beneficial impact of globalization. Union Vs Non-Union Training An important aspect of developing human capital either by firms or by government is to place overwhelming emphasis on training. However, the question is whether to provide union training or non-union training. Under the method of union training, candidates are enrolled under a particular program and these graduates graduate. For instance, industry associations take initiatives apprenticeship program for the potential graduates. When they graduate, these apprentices find themselves employment better than had they received non-union training. An effective way of assessing if union training is a better option as compared to non-union training is to examine the productivity level of graduates. It has been proved that those graduating from union training are more productive. A probable explanation may be found in the very design of union training as they are customized and have content that is targeted to meeting the skill requirement of a sector or industry. Read More