Tools of The Federal Reserve: Discount Rates and Reserve Requirements

The Federal Reserve has three tools to help maintain and make changes within money supply and policies. The first tool and most popular tool is open market operations. The Reserve uses this instrument to regulate the rate of federal funds within the system, which is merely the rate in which banks borrow reserves from other banks. With this tool, they can alter the interest rates and amount of money on the open market. Therefore, the Reserve can essentially control the total money stream, whether that is expanding and contracting it.

There are three available monetary tools: open-market operations, setting the discount rate and reserve requirements

The Federal Reserve exercises its power to stimulate stable employment economies and economic prices. The pursuit of the required employment rate and the creation of price stability, the Federal Reserve can increase or decrease the interest rate.

The CB uses open market operations to buy and sell securities as a means of implementing their monetary policies. They also used the open market operations as a way to control the liquidity of available money by influencing the short term interest and the supply of base money; therefore as a result controlling the supply of money. They also set the target rate for the feds and setting the discount rate at which for member banks to lend money to each other. The Feds also evaluate the bank mergers and also implements foreign exchange policy on behalf of US government and the

The first to be discussed is the discount rate is the interest rate charged by the Federal Reserve to banks for short term loan basis. The increase and decrease of the money supply is determined by the discount rate. Discount rate would be used is a bank needed twenty million dollars, the money would be borrowed from the United States treasury but has to be paid back at a interest rate of three percent. This monetary tool would be used with inflation if the expected inflation increases so will the discount rate and vice versus at the same rate remaining equivalent. During periods of time with high unemployment rate the discount rate is lowered in order to counteract high unemployment and to prevent the possibility of a recession. Secondly, there is the ratio reserve. Ratio reserve is the amount of money that has to be kept at a bank on reserve; this amount can be adjusted to back outstanding deposits. Ration reserve creates the marginal money supply at any given moment due to the Fed raising or lowering the reserve requirements. Although it is rarely used to control the money supply it is a tool that can be used. An example of how it would be used would be if Will comes in and deposit one thousand dollars and the reserve amount is ten percent, of that one thousand dollars one hundred will go to the reserve ratio. Allowing the other ninety percent to be used as a money supply for loans and etc. In the case of unemployment and high inflation the Fed has to lower the reserve ratio in order to decrease the unemployment rate and inflation because if the reserve ratio is lower then the economy and the money supply is moving more vividly. Lastly is the open market operations. Open market operations is the act of buying and selling Treasury securities’ between the Fed and certain selected banks in the open market, it is directed by the FOMC. Open market operations would be considered

In order for the Federal Reserve to fulfill their goal of moderate long term interest rates, stable prices and maximum employment, they rely on developing strategic changes to the monetary policy. Through monetary policy changes, the Federal Reserve can either restrict or encourage economic growth and inflation, thereby molding the macroeconomy into a state of consistent health. Overall, there are three tools used to modify the monetary policy, they include reserve requirements, discount rates, and open market operations. In an effort to promote price stability within the economy, these tools influence monetary conditions by affecting interest rates, credit availability, money supply and security prices. While one tool is use more frequently than the others, all three are necessary in establishing stable economic conditions.

The Federal Reserve Act was signed into law on December 23, 1913. Due to a series of financial panics around 1907, the Federal Reserve (also referred to as the “Fed”) was created by Congress to promote a stable banking system and an active economy. The Federal Reserves’ greatest client and biggest spender is the government of the United States. All proceeds from taxes generated and disbursements are managed through the account that the United States government has set up with the Federal Reserve. The Fed operates independently of the government; however, the Feds’ jurisdiction originates from Congress and the Fed is subject to congressional supervision. Furthermore The President nominates the members of the Board of Governors which must be confirmed by the Senate. The salaries of the Fed are also set and appointed by the government. Although the Fed can exercise freedom in monetary determinations, the existing relationship with the government invites corruption particularly with the present administration and its champagne socialists.

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

United States Federal Reserve system, also known as Federal Reserve or simply “Fed” is the United States central banking system. The Federal Reserve took inception in 1913, after the adoption of the Federal Reserve Act. The United States Congress has mandated three macroeconomic objectives to the Federal Reserve. These are minimum levels of unemployment, prices stability and keeping in check the rates of interests. Over the years, the role of Federal Reserve has expanded. It now formulates the country’s monetary policies, conducts supervision and regulation of the banking institutions, maintenance of the financial

Prior to the institution of the Federal Reserve Act, the U.S. financial system’s basic structure was determined by the National Banking Acts of 1863, 1864, and 1865 (Broz, 1999). The purpose of the legislation was to provide a uniform national currency and to raise revenue for the federal government during wartime (Broz, 1999). While effective in its main purposes, it was flawed in the fact that the increase of available currency had little to no effect on consumer demand which led to large seasonal swings in interest rates and banking panics (Friedman & Schwartz, 168-169). In an attempt to rectify the shortcomings of the National Banking System, government turned to the New York Clearinghouse Association, purportedly known as the first central bank. Originally responsible for the settlement of payments between financial institutions, it was chosen because it was the only source at the time that had the ability to provide funds during high demand periods through a discount window or an open market operation (Broz, 1999). In the end, it failed to maintain an adequate amount of liquid reserves to counteract the monetary crisis‘s that ensued during the agricultural harvest cycles, when currency demands accelerated.

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.

After the Revolutionary War, many of the country’s citizens were in great debit and there was widespread economic disruption. The country was in need of an economic overhaul and the new country’s leaders would need to decide how to do this to ensure the new country did not fall apart. After two unsuccessful attempts at a national banking system, the Federal Reserve System was created by the Federal Reserve Act of 1913. Since its inception, the Federal Reserve System has evolved into a central banking system that grows with the country. The Federal Reserve System provides this country with a central bank that is able to pursue consistent monetary policies. My goal in this paper is to help the reader to understand why the Federal

The Federal Reserve System was founded by Congress in 1913 to be the central bank of the United States. The Federal Reserve System was founded to be a safer, more flexible, and more stable monetary financial system. Over the years, the role of the Federal Reserve Board and its influence on banking and the economy has increased. Today, the Federal Reserve System's duties fall into four general categories. Firstly, the FED conducts the nation's monetary policy. The FED controls the monetary policy by influencing credit conditions in the economy. The FED measures its success in accomplishing these goals by judging whether or not the economy is at full employment and whether or not prices are stable. Not only

Reserve requirements. A reserve requirement is just as it sounds, a required amount that a bank must keep on

The Federal Reserve is the central bank of the United States, its structure combines centralization with regional authority: including a Board of Governors in Washington D.C., a Federal Government Agency, and twelve regional Reserve Banks. One branch in particular, the Federal Open Market Committee, made of twelve Federal officials, is committed to fulfilling its ordinance from congress to promote maximum employment, maintain stable prices, and moderate long-term interest rates. According to the Federal Reserve System online, “The Federal Reserve, the central bank of the United States, provides the nation with a safe, flexible, and stable monetary and financial system.” In order to do this, the Fed meets every six weeks to consider changes in interest rates, and may have an unscheduled meeting at any time in between. The Fed’s responsibilities rest in four categories: monetary policy, financial intermediation through emergency liquidity (as the lender of last resort), supervision of certain types of banks and other financial firms, and establishment of payment system services to financial firms and the government. The primary method of monetary policy is through open market operations and involves the purchase of existing U.S Treasury securities. Through this type of purchase, the Fed increases the reserve base and thereby facilitates the ability of depository institutions, banks, to make loans and expand money and or credit. The Fed traditionally conducts these open