Essay Expansionary Economic Policy

This role is achieved through the implantation of the monetary policies. According to Arnold (2008), Fed has several tools at it disposal that it uses in the monetary polices. These are; the open market operations which involve buying and selling U.S government securities in the financial markets. Further the bank is charged with the responsibility of determining the required reserve ratio. This ratio is given to the commercial banks dictating the minimum amounts that they should hold in to their accounts as deposits and for lending. Finally the Fed sets the discount rates putting in to consideration the overall market rates s well as desired effect on borrowing that the Fed seeks to achieve. In addition to these three major roles, as a bank, the Federal Reserve Bank can play the roles played by the commercial banks as the rules are not entirely prohibitive as far as this duty is concerned.

In order to properly explain the expansionary economic policies that the federal government engages in, it is important to understand the vocabulary being used. The Federal Reserve Bank, commonly referred to as the Fed, “is the central bank of the United States” (Arnold, 2014). According to Steven Pressman (2013), “the Federal Reserve is the institution in which the federal government and private banks do their banking. The central Federal Reserve banks are responsible for monitoring banks and ensuring they remain solvent. They also control interest rates and thus borrowing costs for consumers and business firms. This, in turn, affects unemployment and inflation, giving the Federal Reserve substantial control over the U.S. economy.” Expansionary fiscal policy

For centuries, banks have relied on fractional reserve banking. This is the method in which only a fraction of a bank’s deposits are actually backed by a reserve of cash-on-hand, available for immediate withdrawal. This procedure allows the bank more capital to lend and at the same time, grows the economy. The reserve amounts are determined by a ratio stipulated by the Federal Reserve. In theory, fractional reserve banking works most of the time. However, in difficult economic times, people have demanded to withdraw

The Federal Reserve increases its reserves by issuing loans to a commercial banking system. This allows the bank that is borrowing reserves to disburse credits to the public. The Federal Reserve Banks offer primary credit, secondary credit, and seasonal credit, to bank organizations each with its own interest rate. Depending on if the Fed wants to decrease or increase the interest rate can be a positive or negative effect to the public. If the rate is decreases it encourages banking organizations to get more loans. When this is done the banks acquire more funds and are able to disburse more loans the people.

According to the financial definition, a recession is a significant decline in activity spread across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income, and wholesale-retail trade. The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country's GDP. (Dictionary.com) A less official and more realistic definition of an economic recession is the social perception of the state of the economy at a given time. The collective beliefs of the public, mainly businesses and consumers, drive the social perception of whether things are seen as positive or negative. Unfortunately

One form of direct control can be exercised by adjusting the legal reserve ratio (the proportion of its deposits that a member bank must hold in its reserve account), and as a result, increasing or decreasing the amount of new loans that the commercial banks can make. Because loans give rise to new deposits, the possible money supply is, in this way, expanded or reduced. This policy tool has not been used too much in recent years. The money supply may also be influenced through manipulation of the discount rate, which is the rate if interest charged by the Federal Reserve banks on short-term secured loans to member banks. Since these loans are typically sought to maintain reserves at their required level, an increase in the cost of such loans has an effect similar to that of increasing the reserve requirement. The classic method of indirect control is through open-market operations, first widely used in the 1920s and now used daily to make some adjustment to the market. Federal Reserve bank sales or purchases of securities on the open market tend to reduce or increase the size of commercial bank reserves. When the Federal Reserve sells securities, the purchasers pay for them with checks drawn on their deposits, thereby reducing the reserves of the banks on which the checks are drawn. The three instruments of control explained above have been conceded to be more effective in preventing inflation in times of high economic activity than in bringing about revival from a

They must purchase capital stock in their District Reserve Bank, entitling them to a six percent stock dividend, thus issuing them the right to vote for six of the nine Directors of that District Bank. Within this structure there was the Monetary Control Act of 1980 which imposed a reserve requirement on all depository institutions, which allows them to borrow and receive other services from the Fed. This remains beneficial because by enabling banks to borrow reserves from the Reserve Banks the liquidity of the entire banking system is increased.

A recession is full-proof sign of declined activity within the economic environment. Many economists generally define the attributes of a recession are two consecutive quarters with declining GDP. Many factors contribute to an economy's fall into a recession, but the major cause argued is inflation. As individuals or even businesses try to cut costs and spending this causes GDP to decline, unemployment rate can rise due to less spending which can be one of the combined factors when an economy falls into a recession. Inflation is the general rise in prices of goods and services over a period of time. Inflation can happen for reasons such as higher energy and production costs and that includes governmental debt.

First of all, expansionary fiscal policy is passed to expand the money supply of an economy to encourage economic prosperity, growth, and combat inflation. Inflation is described as the overall increase of prices in an economy or country. There are several ways an

Recession is a term that looms over any society at some point or another but what does recession mean for the economy, in short it is an economic decline. This essay will examine the meaning of recession and will discuss the fiscal and monetary policies that are used to pull economies out of recessions. The great Recession of 2008 will shed light on how these policies were successful at restoring economic growth and reducing unemployment.

In most countries, commercial banks’ reserve accounts with the central bank must have a positive balance at the end of every day; in some countries, the amount is specifically set as a proportion of the liabilities a bank have that is on its customers. This is known as a reserve requirement. At the end of every day, a commercial bank will have to examine the status of their reserve accounts. Those that are in deficit have the option of borrowing the required funds from the central bank, where they may be charged a lending rate which is also referred to as the discount rates on the amount they borrow. In a balanced system, where there are just enough total reserves for all the banks to meet requirements, the short-term interbank lending rate will be in between the support rate and the discount rate. Both the Treasury and the central bank are involved in these reserve management operations to maintain interest rate stability (Palley, 2012). This applies to the relationship between the Central Bank of Kenya and its regulatory requirement to maintain a capping that is below 14%. CBK finances commercial banks at much lower rate on their borrowing so that the banks can fix their interest charges on borrowed money at certain percentage that must not exceed the limit set by the

Under normal circumstances, the Federal Reserve would manipulate the economic situation by manipulating the reserves and by changing the target interest rate (Keister and McAndrews (2009). However, the Federal Reserve has bypassed

Interest rates are considered to be the core of the monetary policy set by economists and policy makers and that is applied by central banks to achieve certain economic objects regarding measures like inflation and output. In other words, interest rates are just means to influence dimensions of macroeconomic activity and central banks usually do not have any inherent preference for one interest rate level versus another. Empirical literature has revealed that changes in the supply of bank reserves are what induce changes in the interest rates set by the central bank which affect changes in other market-determined short-term interest rates as a result. However, changes in the Federal Reserve policy in the 1990s resulted in different findings. The effect of the change of bank reserves on interest rates started becoming smaller over time; small enough that it was impossible to distinguish it from the normal day-to-day variation in reserve supply needed to offset fluctuations in float, or Treasury balances, or other non-policy factors that usually affect banks’ reserve demand (Friedman & Kuttner, 4). For this reason, Benjamin Friedman and Kenneth Kuttner aim to provide a better framework of understanding how central banks set interest rates that does not present the policy interest rate as a primitive one rather one that is more consistent with contemporary monetary policy and that does not center only on the changes in reserve supply against an interest-elastic reserve demand.

The most important tool the Fed has to conduct monetary policy is open market operations, which is the buying and selling of U.S. government securities. A Federal Open Market Committee administers the sale and purchase of U.S. government securities on the open market to influence short-term interest rates and growth of money and credit. Other tools that the Fed has it its disposal to influence the economy include adjustments to the discount rate and the reserve requirement, and acting as a lender. The discount rate is the interest rate the Federal Reserve Banks charge financial institutions for short-term loans of reserves.

Discount rate. The discount rate is defined by the Federal Reserve as, “ how much the United States central bank charges its member banks to borrow from its discount window to maintain the reserve it requires” (www.federalreserve.org). If for example, the discount rate is set low, banks will be more likely to borrow from the central bank and increase the reserves. With increased reserves the federal funds rate will also decrease, which in turn will indirectly effect all other aspects of the economy. The reverse is true as well, if the discount rate is set high, the banks will borrow monies from one another rather than from the Federal Reserve.