Abstract
Federal Reserve, also known as the FED, is the key player in the economics of the United States, being the main agency that determines the interest rates and the use of various mechanisms to control the economy. At the same time, the agency does not always demonstrate wise actions, resulting in extreme recessions and depressions, causing issues with unemployment, inflation, and reduced consumer spending. Overall, this paper argues that despite the history of major failures, such as the ones involving the Great Depression and the Great Recession, the primary tools to promote recovery are focused on liquidity, open market operations, and interest rates.
Introduction
The Federal Reserve is the primary regulator of monetary policy in the American economy. Because the agency cannot always operate sensibly, there were instances of severe recessions and depressions, which led to significant financial problems. The main instruments to encourage recovery are concentrated on liquidity, open market operations, and interest rates, notwithstanding the history of significant failures, including the Great Depression and the Great Recession.
Functions of the FED
Prior to delving deeper into the intricacies of the Federal Reserve’s actions, it is necessary to give an overview of its main functions. To support full employment, price stability, and lower long-term interest rates in the national economy, the Federal Reserve sets the country’s monetary policy (Boone et al., 2021). Moreover, it encourages the financial system’s health and works to reduce and limit systemic dangers by actively monitoring and intervening both domestically and internationally (Boone et al., 2021). Furthermore, the FED controls each financial institution’s solidity and security and monitors how it affects the economy as a whole (Boone et al., 2021).
Finally, the organization provides services to the banking sector and the United States government that enable financial transactions and payments in the U.S. currency, thereby promoting the security and effectiveness of the payment and resolution processes (Boone et al., 2021). Therefore, one can see that the main role of the FED lies in ensuring the protection of the general public and financial system through several mechanisms.
Addressing Recessions and Depressions
The Great Depression
One of the major financial struggles experienced by the U.S. was the Depression in the 20th century. The Fed’s decisions regarding increasing interest rates in 1928 and 1929 illustrate the beginning of the instability (Federal Reserve History, n.d.). The Federal Reserve took this action to curb volatility in the stock market (Federal Reserve History, n.d.). Meanwhile, while controlling the stock market, the nation’s economic growth was hindered (Federal Reserve History, n.d.).
Moreover, further global recessions were sparked by the Federal Reserve’s actions because the global gold standard connected interest rates and monetary policies among member countries (Federal Reserve History, n.d.). Consequently, the Federal Reserve’s efforts were designed to keep the gold standard in place and manage inflation, but they unintentionally worsened the recession.
The 2008-2009 Recession
Another unprecedented financial issue was the recession of 2008-2009 which had not been seen since the Great Depression. On September 15, 2008, the day Lehman Brothers declared bankruptcy, Senator John McCain remarked that the American economy was solid. However, the economic downturn of the late 2000s—now known as the Great Recession—was severe (Kus, 2020).
The government’s first approach was to figure things out as it went along, implementing several emergency measures meant to stop the economy’s bleeding (Kus, 2020). A number of unconventional monetary policy initiatives were carried out by the FED, such as the near-zero interest rate reduction and the massive asset purchases, or “quantitative easing,” intended to infuse liquidity into the banking sector (Kus, 2020). Such policies attempted to boost consumer spending, investment, and borrowing to aid in the recovery of the economy.
Recovering from a Recession
The first line of defense against a recession is to stimulate the economy by lowering interest rates. Monetary policy is based on the fundamental tenet that lower interest rates encourage investment and consumption, which moves the curve of aggregate demand to the right (Boone et al., 2021). Reduced interest rates encourage consumers to spend more, making it more appealing to take out loans to purchase costly goods such as homes and cars (Boone et al., 2021). Furthermore, as more possible investment projects profit from less interest, lower interest rates encourage corporations to spend money on investments (Boone et al., 2021). In other words, firms will only borrow capital to invest in initiatives with rates of return greater than the current interest rate.
Another approach to help the financial system recover from a recession is to supply banks and depository institutions with short-term liquidity. This can be mostly done by adjusting the discount rate and offering short-term loan facilities that are only temporary (Lee et al., 2020). By taking these steps, member banks’ borrowing rates were essentially lowered to zero (Lee et al., 2020). Finally, in order to effectively lower the cost of borrowing below zero, open market operations are used to buy mortgage-backed securities along with other securities (Lee et al., 2020). Consequently, such actions promote a quicker recovery and confidence of both the general public and businesses.
Conclusion
In conclusion, liquidity, open market operations, and interest rates continue to be the primary instruments for fostering recovery in spite of previous major setbacks such as the Great Depression and the Great Recession. The main duty of the Federal Reserve is to protect the financial system and the general public using a variety of strategies. The Depression was one of the United States’ most significant financial setbacks throughout the 20th century. The recession of 2008–2009 was another extraordinary financial problem. Lending rates, market operations, and liquidity mechanisms facilitate a more rapid recovery and bolster public and corporate confidence.
References
Boone, L. E., Kurtz, D. L., & Canzer, B. (2021). Contemporary business. Wiley.
Federal Reserve History. (n.d.). The Great Depression. Web.
Kus, B. (2020). Relief, recovery, reform: A retrospective on the US policy responses to the Great Recession. Intereconomics, 55(4), 257-265. Web.
Lee Jr., R. D., Johnson, R. W., & Joyce, P. G. (2020). Public budgeting systems. Jones & Bartlett Learning.