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Federal Reserve and the Role of Money in It Expository Essay



Since the historical times, the concept of money has been there, with the only notable differences being in terms of form. Generally, money can be viewed as any object that serves as a means of payment for the receipt of goods or services within a nation. Money can take two distinctive forms: commodity money and fiat money.

Almost all money systems in the world are based on Fiat Money; money that has no intrinsic value for use as a commodity, but derives its value through government declaration as legal tender; implying that it must accepted as a means of payment within and outside the country (Lawrence J. Gitman, 2007). The supply of money within a country is in the form of currency and demand deposits.

Demand deposits usually constitute a larger fraction of the supply of money within nation than the currency. It is interesting to note that Bank Money is intangible, and cannot be available for use at a particular moment unless transformed into currency ( World Bank, 2003).

The Purpose and Functions of money

Classical economics states that money constitutes of four chief functions: medium, measure, standards and store. Money used in this form eliminates the inefficiencies associated with the traditional barter system, for instance double coincidence of wants. In this context, money can be viewed as a unit that is used to measure the worth of deferred payment. From this perspective, money as a unit of account is a key requirement during the making of agreements that entail debt or future payments.

For money to serve as a unit of account it must be separable into smaller units, without actually losing its value; it must be fungible, meaning that a unit has to be an equivalent of any other; it must also have the attributes that makes it countable or measurable (Norman & Warren, 1972).

Money as a store of value implies that money must possess the characteristics which make it be saved and retrieved for use as a means of foreign exchange. It is imperative that the value for money should be constant and stable for a considerable duration of time. Cases of inflation are due to lack of stability for the value for money.

The Role of the central bank in managing the monetary system of a country

The central bank has the responsibility of issuing currency, regulating the flow of currency within a country and managing the interest rates. One of the primary functions of the central bank is to manage the monetary system of a country.

In order to effectively manage the monetary system of a country, the central bank has to carry out some responsibilities such as implementation of the monetary policy, controlling the interest rates of the currency of the country, keeping in check the flow of money within the country, establishing of the official interest rate which can be used to manage the inflation and the exchange rates of a country and controlling the levels of government borrowing or lending (Lawrence J. Gitman, 2007). Choosing a monetary policy entails the adoption of the form of money to be used within the country.

Issuing currencies is a form of earning money by the central bank since the money are issued to the public at an outstanding interest rate through use of government bonds.

Direction of recent monetary policy in the United States

The policy seeks to enhance price stability and increase the employment rates. Presently, the rates of unemployment are increasing and the measures deployed to combat inflation are low. The policy implemented seeks to increase resource utilization in the process of ensuring price stability. The monetary policy also aims at promoting a stronger pace in terms of economic recovery, and to make sure that the levels of inflation are consistent with the mandate under the monetary policy.

One of the policies that the Federal Reserve has employed towards the realization of the recent monetary policy is through keeping constant the target values for the federal reserves between 0-0.25 % and subsequent monitoring of the financial developments (Lawrence J. Gitman, 2007).

Effects of the monetary policy on the economy production and employment

One of the elements of the monetary policies is taxation. An increase in the tax rates implies reduced income. Organizations on the other hand base on the profitability to evaluate the amount of workforce t can sustain. A decrease in tax implies that organizations have the capability to sustain a larger workforce and vice versa (Auerbach, 1997).

Interest rate is a significant concept of the monetary policies. Changes in the interest rates have adverse effects on the production of a country through altering the way money increases. Generally, increase in interest rates makes cash to be scarce; as a result, an increase in credit, which implies that production, reduces. Similarly, reduction of the interests makes cash to be more available, hence a reduction in credit, implying that production increases ( World Bank, 2003).


It is evident that money plays an important role in the economy of a nation. Therefore, effective strategies and policies should be deployed by Central Bank of a particular country to make sure that value of nation’s currency is maintained at required levels. Maintaining a constant supply and regulating the monetary values of a given currency play a significant role controlling the levels of inflation of a particular country.


World Bank. (2003). World Development indicators 2003. Washington: World Bank Publications.

Auerbach, A. J. (1997). Fiscal Policy: Lessons from economic research. Cambridge: MIT Press.

Lawrence J. Gitman, M. D. (2007). Personal Financial Planning. London: Cengage Learning.

Norman, T., & Warren, F. (1972). The Political economy of development: theoretical and empirical contributions. California: University of California Press.

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