Structure Underlying the Federal Reserve - Essay Example

Macro9 Table of Contents Answer to Question 3 Answer to Question 2 4 References 6 Gwartney, J. D., Stroup, R. L. Sobel, R. S. & MacPherson, D. (2009). Economics: Private and Public Choice. New York, USA: Cengage Learning. 6 Hirshleifer, J., Glazer, A. & Hirshleifer, D. (2005). Price theory and applications: decisions, markets, and information (7 ed.). New York, USA: Cambridge University Press. 6 Mankiw, N. G. (2007). Principles of Macroeconomics. New York, USA: McGraw-Hill. 6 Minsky, H. P. (2008). Stabilizing an unstable economy. New York, USA: McGraw-Hill Professional. 6 Answer to Question 1 Ideally, money is defined as an instrument that satisfies four core properties, viz., medium of exchange, unit of account, store of value and standard for making deferred payments (Mankiw, 2007, p. 2). However, this classical definition of money can no longer contain the properties of money which have so vehemently exposed them through elongated phases of credit crisis and liquidity crunch. To be precise, money can no longer be treated as a store of value in an age of vigorous price instabilities when value of money hardly stays fixed at a particular point. ‘Store of value’ is a term that intrinsically refers to an instrument which can be saved today with the faith that a commodity of equivalent value could be obtained in lieu of the sum at some future period. In other words, possessing a fixed sum of money X today would mean the possessor’s purchasing power amounting to X, as long as she keeps it to herself, i.e., the value of this amount X is assumed not to depreciate (Hirshleifer, Glazer & Hirshleifer, 2005, p. 442). However, post the tumultuous phase of the global financial community, such a term is no longer applicable as money saved today is seldom expected to possess the same value tomorrow. This is especially so due to the policies of the central bank of any economy that brings changes to the value of money according to the demands of the prevailing economic situation. During recessions, value of money is found to grow higher while it deteriorates during times of inflation. In the latter phase for instance, the same amount of money X can buy a much lower quantity of goods than it could have during the earlier period. In such a scenario, it is safer for the economists to assume a definition of money that hints towards the inclusion of relatively illiquid assets, i.e., those which cannot be circulated as smoothly as others and not readily accepted as modes of payments. In such cases, there longer exists any motive behind increasing the supply of money. According to the identity underlying the Quantity theory of money, MV ≡ PT, where, M = Money Supply, V = Velocity of money, P = General level of price and T = Number of transactions in an economy Normally, during times of inflation, purchasing powers of people fall, so that T falls in value. On the other hand, recessions enhance the purchasing power of people so that T rises. Hence, assuming the product of P.T to be constant, movements in V are bound to be reflected through inverse movements in M (Minsky, 2008, p. 125). Thus, it is safer to include those goods within the sphere of money which have a low velocity (V), since they also ensure a more-or-less constant supply of money, i.e., one whose value can certainly be stored. Answer to Question 2 The adjoining diagram shows the structure underlying the Federal Reserve. Basically it comprises of the following components – Board of Governors There are 7 Board of Governors in the Federal Reserve, each of whom are being appointed by the President of USA, after discussion with the Senate. These governors are chosen after a thorough consideration of their respective domains so as to represent every major sector of the economy justly. These governors are mainly responsible for framing monetary policies and monitoring their efficient and effective exercise. Thus, the primary job of the governors is to keep vigilance of the general price level so as to maintain financial and economic stability in the nation. Furthermore, it also is responsible for regulating and supervising the activities of various banks affiliated to the Federal Reserve. Federal Reserve Banks There are 12 Federal Reserve Banks located in 12 different cities throughout the USA. Their purpose is to inspect the effective implementation of the policy measures suggested by the Board of Governors. These banks assume the role of being fiscal agents to the Federal government, i.e., perform open market operations of government bonds and securities. Furthermore, these banks maintain transaction accounts for the Treasury, collecting and supplying funds on behalf of the Fed. These banks also are responsible for the circulation of money in the economy; it is through them that the member banks and depository institutions financially serve the people of America. Member Banks and Other depository institutions Lastly, the member banks comprise of every national bank chartered by the Federal government. These banks which form the base of the pyramid are responsible for supplying money to the people of America or accepting deposits from them. In other words, the member banks are the banks of the American citizens while the Federal Reserve Banks are the banks to the Federal government (Smale, 2005). Importance of Federal Open Market Committee The federal Open Market Committee is an important part of the Federal government responsible for analysing the impact that a particular monetary policy instrument might have upon the economy and thus advising the Board of Directors suitably. It takes into consideration both the short and the long term impacts of undertaking a particular monetary policy in the economy. The Committee comprises of all the seven Board of Directors of the Federal governor along with the President of the New York district bank and any four of the remaining 11 Federal Reserve banks. The Committee meets every 4 to 6 weeks and decide upon the next monetary measures to be undertaken through an evaluation of the present financial status of the economy (Gwartney, Stroup, Sobel & MacPherson, 2009, p. 274). References Gwartney, J. D., Stroup, R. L. Sobel, R. S. & MacPherson, D. (2009). Economics: Private and Public Choice. New York, USA: Cengage Learning. Hirshleifer, J., Glazer, A. & Hirshleifer, D. (2005). Price theory and applications: decisions, markets, and information (7 ed.). New York, USA: Cambridge University Press. Mankiw, N. G. (2007). Principles of Macroeconomics. New York, USA: McGraw-Hill. Minsky, H. P. (2008). Stabilizing an unstable economy. New York, USA: McGraw-Hill Professional. Smale, P. (2005). Structure and Functions of the Federal Reserve System. CRS Report for Congress. Available at http://www.fas.org/sgp/crs/misc/RS20826.pdf (Accessed: November 23, 2010). Read More