ABSTRACT
Federal Reserve Bank, commonly known as FED, has been established with the aim of stabilizing the overall financial system within the US economy. FED has been using different tools and methods like open market operations, moral suasion, discount rate, and the reserve requirements in order to achieve the overall economic goals. These economic goals include; reducing unemployment and inflation, and accelerating the process of economic growth. In order to overcome the today’s economic challenges, the chairman of Fed should work on controlling the monetary measures and pulling strategies which benefit the global economic growth.
INTRODUCTION
Money market is a place where the lenders and borrowers meet for satisfying their short term financial needs. It provides the retail investors a safer platform for making short term investments. Earlier the money markets were considered to be less volatile but after the global financial crisis the perspective of the people changed. For safeguarding the rights of the investors and regulating the money markets the Federal Reserve Bank is playing a pivotal role (Dodd, 2012).
The Federal Reserve Bank also referred to as the FED is the central bank of the U.S. economy. The purpose of creation was providing a more stable financial system to the economy. The core responsibilities of the bank include balancing the monetary policy, regulating other banks and take measure for managing systematic risk. In this report a discussion will be presented for signifying the presence of Federal Reserve in the economy. Different aspects of FED’s presence signify the goals of the national economy, its impact on the present economy, discussion of economic stimulus and traditional and non-traditional economic measures which are required for stabilizing the economy (Kemmerer, 2006).
FEDERAL RESERVE
The Federal Reserve Bank is a central bank of the U.S. which operates in collaboration with several public and private sector institutions. It fosters the safety and vitality of the economic and financial systems. The bank is assigned the roles of operating the nation’s payment systems and protecting the consumer rights. The Federal Reserve Bank is a non-profit banking institution. It is a state owned bank and certain amounts of its stock are awarded to the members of the system. The holders of the stock are bound not to sell or pledge the stocks for acquiring loans. The dividend offered by law to the holder is 6% annually (Meltzer, 2010).
The role and responsibility of the Federal Reserve covers four major areas which are following (Cecchetti, 2009):
- Structuring the nation’s monetary policy with the objective of acquiring full employment and price stability.
- Regulating the banking institutions for ensuring safety and soundness of the financial system.
- Take measures for containing systematic risk which may arise in the financial markets.
- Monitoring and operating the nation’s payment system.
The Federal Reserve Bank acquires most of its earnings from interest which is acquired from U.S. government securities. These securities are acquired through the open market operations. The bank also earns interest on the foreign currency investments. After completing all the expenses the bank turns in all its earnings in the U.S. treasury. The functions of the bank are regularly audited and reviewed. This is for ensuring that whether the compliance and regulations imposed are being properly implemented on the system. 38% of 8039 commercial banks situated in the U.S. are members of the Federal Reserve System. The member banks are considered as stockholders of the banks. It has been made mandatory on these institutes to hold stocks which are worth 3% of their capital as stocks in the reserve banks. All these practices including other depository institutions and the people residing in America form the Federal Reserve Banks (Meltzer, 2010).
ROLE OF FEDERAL RESERVE ON THE ECONOMY SINCE 2000 TO PRESENT
The role of Federal Reserve in dealing with systematic risk has been a question mark since the 2008 meltdown. The span of control of the bank has expanded along with the kinds of financial institutes which are being monitored and regulated. This may increase the vulnerability of the institutes. The advent of 2008 has prepared the bank for overcoming such events which may arise in the future. The bank has failed to realize the fact that the grounds which led to the global financial crisis were set by FED itself (Horwitz, 2013).
The housing boom arose because of the discrepancies of the economies. The U.S. economy tried to minimize the impact of recession which arose after the 9/11. FED expanded the overall money supply which dropped down the interest rate to extremely low levels. All these practices implemented by the bank laid the building blocks of the global economic recession. The interest rates of all the commercial banks went to an all time low which motivated the people to take loans and invest them in the mortgage property. The prices of the properties hiked and significantly impacted on the U.S. treasury. All these steps gave rise to the systematic risk which eventually resulted in the collapse of the economy (Horwitz, 2013).
All these events caused in the past have somewhere been initiated by the discrepancies of the Federal Reserve Bank. Although the FED’s claim that they have assessed the systematic risk and they can prevent this problem in the future the FED’s are considered to be the ones which have been responsible for this problem.
ROLE OF FED IN MEETING ECONOMY’S GOAL
FED has a very prominent role in addressing the economic growth objectives of the U.S. economy. This is because it is linked to designing the monetary policy of the economy. The objectives of the monetary policy are to stabilize inflation rate, minimize unemployment and sustain economic growth (FRBSF, 2004; Rudebusch, 2001).
Unemployment: Unemployment causes economic instability and hence requires to be minimized. This can be done by creating new jobs for the people. Staying employed and utilizing products is the method which brings rotation to the business cycle. All these factors balance the demand and supply cycle of the economy. The monetary policy plays a pivotal role in indirectly stabilizing the economy. In the recession the demand of the products weakens and this results in less production. If the interest rates are reduced by the FED’s at that time then the people may consider spending more rather than saving (FRBSF, 2004; Rudebusch, 2001).
Inflation: The persistent increase in the price level is referred to as inflation. High inflation rate reduces the purchasing power of people. The measurement of the inflation rate is done using several different price indexes. The affect of interest rate on the economy determines the behavior of the people. Interest rates are also set considering the varying economic conditions. Inflation rate is used by the economies as a tool for reducing the velocity of recession. Regulators and central banks are responsible for designing the monetary policies and set the interest rates which eventually control the inflation rates. High inflation rate hinders economic growth. This is the reason why regulators and central banks like the Federal Reserve Bank are designated the authority for setting the monetary policies and take measures for controlling the inflation rates. The significant drawback of excessively high inflation rate is that it disrupts the economic growth and reduces the buying power of money.
Economic growth: Economic growth is responsible for bringing stability in the economy. FED uses several tools and proposes various methods such as reducing unemployment, controlling the inflation rate and managing the interest rates for sustaining the economic growth. These are also called as the economic growth objectives. All these measures aid the economies in meeting the economic goals and objectives of the economy (FRBSF, 2004; Rudebusch, 2001).
FED’S TOOLS
FED uses certain tools for controlling economic stability and sustaining the economic growth (Sack, 2000). These objectives are achieved by the bank by enforcing on commercial banks several different practices mentioned below.
Maintain specific reserve requirements: Central banks often impose policies which suggest that they must maintain specific reserve requirements. This is to sustain liquidity which does not lead the banks towards closure or default (Sack, 2000).
Open market operations: The banks ensure that the open market operations are closely monitored. This shows that the banks take measures to ensure that the rights of the investors are secured. Monitoring these operations ensure stability of the banks and lead the economy towards stability (Sack, 2000).
Discount Rate: The FED also offer a minimal discount rate which is the interest rate charged to the commercial banks and other financial institutes when they borrow money from their regional central banks. Three kinds of instrumental discount rates are offered to other commercial banks. These three instruments are primary credit, secondary credit and seasonal credit and all these instruments have varying interest rates. All of these forms of discounts which are offered interbank are fully secured (FRG, n.d.).
Moral suasion: The moral suasion is a term used for the measures taken by the authoritative institutions such as the FED to exercise pressure but not force other banks towards complying with the prescribed policies. The tactics which are used by such institutions are conducting meeting with the bank directors, conduct inspections, give rise to the community spirits or pose threats. All these measures are taken by FED when they require exercising pressure on other institution for getting things done (Furfine, 2006).
All the tools which have been discussed above are used by FED for strengthening the monetary measures. All these stabilize the economy by controlling the inflation and interest rates. Economic growth is impacted by lot of measures and controlling these objects is essential for stabilizing the economy. For meeting the economic goals the regulating bodies and the concerned institutions design the measures which can benefit the system (Sack, 2000).
The role of the FED is to monitor the chances of systematic risk. The failure in foreseeing the risk which struck the U.S. economy impacted the entire global economic environment. For reversing the effect of recession and stabilizing the economy measures must be taken which may safeguard the investors and lead the economy towards stability.
STEPS TOWARDS STABILIZATION IN THE COMING YEARS
The steps which are required by the FED to be taken in the coming 12 to 24 months are that they need to firstly ensure that the GDP rate is stabilizing. The global economy is producing $2-3 trillion less than the actual figures. Stabilizing the economy and controlling the GDP rate is essential and measure for doing so are urgently required. If the economy fails to realize all these factors then it will be observed that more students will be staying back home. If GDP and economic growth will not increase then inflation rate will peak and so will the unemployment rate. The chairman requires controlling the monetary measures and pulling strategies which benefit the global economic growth.
DISCUSSION OF ECONOMIC STIMULUS EFFORTS OVER THE LAST FIVE YEARS
Economic stimulus is an attempt taken by the government to maintain financial growth. The monetary and the fiscal policy are terms which denote directly to the economic stimulus. These policies are measures for directing the economy out of economic lag and struggle for stability. The measures discussed above such as reducing the interest rates and increasing government spending are used for stimulating the economy and generating cash flow (Houser, Mohan, & Heilmayr, 2009).
The FED has taken aggressive measures for stabilizing the economy. They have taken measures for reversing the financial crisis. The actions which have been taken by the FED include the following (FRBSF, n.d.; McGrane, 2013):
- Stabilizing the financial policies and system.
- Respond to the global recession and induce the methods for increasing the GDP.
- Safeguard the rights of the investors and at the same time induce sound banking policies.
- Suggest measures for ensuring that the banks don’t fall subject to the global recession.
- Pressurizing the banks for complying with the economic changes.
- Offering interest rates which may stabilize the economy.
According to Appelbaum (2013), after all the efforts for achieving economic stability taken by the Federal Reserve, the economy has showed signs of stabilizing. Yet the economist suggested that the economic stimulus need to be continually applied. Application of high interest rates was suggested for acquiring the mortgage loans. These measures taken and the implementation of economic stimulus suggest excessive market volatility. The unemployment rate in the economy has been maintained at a mere 6.5% (Appelbaum, 2013).
All these are the measures which have been taken by the economy for stabilizing the economy over the years. These measures lead the economy towards stability and growth. All the measures which have been suggested show that FED has taken appropriate steps for dealing with the systematic risk. Altering the monetary policy and the fiscal policy according to the economic requirement has reduced the chances of systematic risk. Economists suggest that all these actions and measures can reduce the effect of risk. Measures for mitigating the risk seem to be impossible.
CONCLUSION
The role of the Federal Reserve Bank in reducing the risk in the economy has been significant being a central bank. The economy uses several tools like increasing the interest rates for motivating the people to save or reducing the interest rates for attracting borrowing. Controlling the inflation rate so that the value of money does not reduce is also significantly important. All these factors aid the economic growth and stability. The role of the FED in monitoring the economic growth and analyzing economic risk is significantly important. Although the institution has not succeeded in assessing the risk but the measures taken by it for reducing the economic impact are significantly important.
The discussion presented in this report shows the measures taken by FED for economic growth and stability. The role of the institution in designing an appropriate monetary and fiscal policy is shown. Besides this there are several tools which are used by the institution. The application of these tools leads the economy towards growth and stability. The actions taken at the time of the global recession by the FED have played pivotal role in stabilizing the economy and this shows the importance and significance of this institute. This shows that the effect of risk can be minimized but it cannot be mitigated.
REFERENCES
Appelbaum, B. (2013). In surprise, Fed decides to maintain pace of stimulus. Retrieved November 10, 2013, from http://www.nytimes.com/2013/09/19/business/economy/fed-in-surprise-move-postpones-retreat-from-stimulus-campaign.html?_r=0
Cecchetti, S. G. (2009). Crisis and responses: the Federal Reserve in the early stages of the financial crisis. The Journal of Economic Perspectives, 23(1), 51-76.
Dodd, R. (2012). What are the money markets? Finance and development, 49(2), pp. 46-47. Retrieved November 10, 2013, from http://www.imf.org/external/pubs/ft/fandd/2012/06/pdf/basics.pdf
FRBSF. (2004). What are the goals of US monetary policy? Retrieved November 10, 2013, from http://www.frbsf.org/us-monetary-policy-introduction/goals/
FRBSF. (n.d.). Fed’s response. Retrieved November 10, 2013, from http://sffed-education.org/econanswers/response.htm
FRG. (n.d.). The discount rate. Retrieved November 10, 2013, from http://www.federalreserve.gov/monetarypolicy/discountrate.htm
Furfine, C. (2006). The Costs and Benefits of Moral Suasion: Evidence from the Rescue of Long‐Term Capital Management*. The Journal of Business, 79(2), 593-622.
Horwitz, S. (2013). The Fed: firefighter or arsonist? Retrieved November 10, 2013, from http://www.usnews.com/opinion/blogs/economic-intelligence/2013/05/20/the-federal-reserve-ignores-its-own-role-in-the-financial-crisis
Houser, T., Mohan, S., & Heilmayr, R. (2009). A Green Global Recovery?: Assessing US Economic Stimulus and the Prospects for International Coordination. Peterson Institute for International Economics.
Kemmerer, E. W. (2006). The ABC of the Federal Reserve System: why the Federal Reserve System was called into being, the main features of its organization, and how it works. Kessinger Publishing.
McGrane, V. (2013). When is the next financial crisis? Retrieved November 10, 2013, from http://blogs.wsj.com/economics/2013/11/08/when-is-the-next-financial-crisis/
Meltzer, A. H. (2010). A History of the Federal Reserve, Volume 2. University of Chicago Press.
Rudebusch, G. D. (2001). Is the Fed too timid? Monetary policy in an uncertain world. Review of Economics and Statistics, 83(2), 203-217.
Sack, B. (2000). Does the Fed act gradually? A VAR analysis. Journal of Monetary Economics, 46(1), 229-256.
