The Federal Reserve: The Gatekeeper of the U.S. Economy

Topics: Monetary policy, Central bank, Federal Reserve System Pages: 13 (5283 words) Published: May 12, 2014

Name: Umer Faiz Siddiqui
Class: BBA-IV
DHA Suffa University
Question 1: Write a note on The Federal Reserve System.
The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed), is the central banking system of the United States. It was created on December 23, 1913, with the enactment of the Federal Reserve Act. Over time, the roles and responsibilities of the Federal Reserve System have expanded, and its structure has evolved. Events such as the Great Depression were major factors leading to changes in the system. The U.S. Congress established three key objectives for monetary policy in the Federal Reserve Act: Maximum employment, stable prices, and moderate long-term interest rates. Its duties have expanded over the years, and today, according to official Federal Reserve documentation, include conducting the nation’s monetary policy, supervising and regulating banking institutions, maintaining the stability of the financial system and providing financial system and providing financial services to depository institution, the U.S. government and foreign official institutions. The Federal Reserve System’s structure is composed of the presidentially appointed Board of Governors (or Federal Reserve Board), the Federal Open Market Committee (FOMC), twelve regional Federal Reserve Banks located in major cities throughout the nation, numerous privately owned U.S. member banks and various advisory councils. The primary motivation for creating the Federal Reserve System was to address banking panics. Other purposes are stated in the Federal Reserve Act, such as “to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes”. Before the founding of the Federal Reserve System, the United States underwent several financial crises. A particularly severe crisis in 1907 led Congress to enact the Federal Reserve Act in 1913. Today the Federal Reserve System has responsibilities in addition to ensuring the stability of the financial system. _____________________________________________________________________________________

Question 2: What is the most important instrument of monetary policy and why? Explain it. The most important instrument of monetary policy is the open market operations. An open market operation is an activity by a central bank to buy or sell government bonds on the open market. A central bank uses them as the primary means of implementing monetary policy. The usual aim of open market operations is to manipulate the short-term interest rate and the supply of base money in an economy, and thus indirectly control the total money supply, in effect expanding money or contracting the money supply. This involves meeting the demand of base money at the target interest rate by buying and selling government securities or other financial instruments. Monetary targets, such as inflation, interest rates, or exchange rates, are used to guide this implementation. Let’s take a look on the process of open market operations. Since most money now exists in the form of electronic records rather than in the form of paper, open market operations are conducted simply by electronically increasing or decreasing the amount of base money that a bank has in its reserve account at the central bank. Thus, the process does not literally require new currency. However, this will increase the central bank’s requirement to print currency when the member bank demands banknotes, in exchange for a decrease in its electronic balance. When there is an increased demand for base money, the central bank must act if it wishes to maintain the short-term interest rate. It does this by increasing the supply of base money, the central bank must act if it wishes to maintain the short-term interest rate. It does this by increasing the supply of base money. The central bank goes to the open market to buy a...

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