The world is recovering from the world crisis that hit beginning 2007. Different governments (as individual governments and as regional bodies) are working on policies that will ensure that they successfully win the battle of recession. The Federal Reserve System was one of the measures taken by the central bank in the United States of America since 1913 aimed at giving the government some control over the economy.
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The system was adopted after the experience that the country had in 1907 when there was a near financial crisis in this nation. Through age and evolution of the world economies, the system has changed and adopted means to control the economy that are responsive to the current operation in the economy (Ambachtshee, Beartty & Booth, 2008). The Great depression is one of the occurrences that have led to the changes in the system; however the system maintains its main goals, which are;
- Enacting monetary guiding principles and ensuring that the policies are working for the general good of the economy
- Regulating how commercial banks conduct their businesses
- Ensuring that it supervises and controls how financial system operates in the country
- Offering depository services to commercial banks
What Function do they play in Our Economy?
The system was aimed at ensuring that the government protects it economy in times of panic or financial crisis. It is through the system that the government can enact policies that lead to expansion or contraction of the economy. Governments play an important role in controlling how their country’s economy fair.
In a broader perspective, they use monetary and fiscal policies for contraction or expansion reasons. When regulations are made they may hurt or benefit the economy both in short term and long term. Financial market is one of the areas that the government exercises its controlling power; the end result is felt in the entire country.
Financial industry effects on the economy are more indirect than direct; they are involved in mobilization of resources, giving out credit, hedging out risk, pooling and sharing of resources. Investors, small businesses, and multinational firms are affected positively or negatively depending on the regulation at hand. Recognizing the need of regulation the United States of America passed a Finance bill on August 2010 that is aimed at being an addition regulating financial markets policy.
What tools do they have at their disposal and how have they specifically used the tools during this recession we have been going through
There are generally three tools of manipulation that the government uses to control the economy. These tools include;
- Open market operations
- Interest rates
- Reserve requirements
Banks operate with a loan facility that they are given by the central bank. The central banks in various countries issue the loans to banks at a certain rate of interest. The banks on the other side have the objective, like any other business, of making profits; the major source of their income is from loans given to their customers. When they are lending to the outside customers they have to charge an interest that is higher than that that the central bank is offering.
In cases of inflation the economy has more funds in circulation than it should be having; this makes the cost of goods expensive, a thing that has negative effect on the growth of the economy and discourages foreign and local investments. There are various reasons that can make the central bank to increase the rate of interest. This use mostly monetary policies and fiscal policies that are used to cure inflation in the country.
Money get into the country through the operating commercial banks and so if borrowing money is made more difficult then the flow of currency in the economy is regulated. For this to happen it is a series of activities where the particular country’s central bank is involved. It thus follows that the rate at which the central bank offers advances to commercial banks will determine the rate at which commercial banks offers loans to the public.
If central bank offers credit to the banks at a higher rate, then the rate of interest that commercial banks will offer loans to the general public will be high as well; this reduces the attractiveness of the facility and in return reduces the flow of money in the economy. If there is need to increase the circulation of money in the economy then the same way can be used; central bank reduces the rate at which it led commercial banks subsequently the banks can offer loans to their customers at a low rate.
The system works on the simple principal that if the bank lending rate is high, then the loans are not attractive and thus the money in circulation will be reduced. This on the other hand cures inflation. These are short term and medium term policies. During the world crisis, the United States government has been using both expansion and contraction methods of economy control (Epstein & Martin, 2003).
There are long term policies that central bank employs they include; issue of treasury bills and bonds and direct participation in the market. Treasury bills and bonds are offered for the general public and companies to buy. In the global financial crisis, the money in the economy has been reduced because of the increased cost of goods.
The government bought more treasury bills and bonds and also reduced their interest rate to discourage people from buying them but focus their money in different sectors of the economy. Anyone buying the treasury bills has the intension of making make a gain after they mature. If the interest rate is high then it means that the money in circulation in the economy is low. In this case, central bank can decide to lower the interest rate on their bonds and bills or remove them from the market all together.
When the rate rises, the loan purchasers’ will be discouraged from buying them and circulate the money in other areas of the economy and thus curing the deficit. When the circulation of money in the economy is higher than the equilibrium then the central bank can aim to offer attractive interest rates; this makes them attractive and the money holders opt to buy them instead of keeping money. It also stops participating in the market. This will make the rate of interest in the country to increase.
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The other way that the banks interest rates are adjusted is by any adjustment of the liquidity fund. By liquidity fund we mean that the money that central bank requires a bank to hold at one time, which is a percentage of the bank’s capital. If the amount is increased, it means that the money available for lending have been reduced and thus the money available can only be lend at a high interest rate (Broz, 1997).
There have been some issues with federal banking system for a long period of time till 2009; the policy was brought in court to defend its stand. The main area of contention was the fact that there are some loans and some information of the system that is not disclosed to the public but the system says it requires the information as secret.
Some banks have argued that this may be a dubious way through which some banks get access to cheaper loans and thus they compete with others not at the same platform since they are favored by the system. Secondly, these secrets are thought to be used by some individuals for political reasons like manipulating the economy.
Despite this augment, on its side the Fed system argues that the information is required in the operation of the economy. It argued that if the information it is holding gets to the public, it is likely to cause speculation which will injure the economy (Dhameja, 2010).
As the world recuperates from the global recession, the intervention of the government is required to control how the economy is operating. The fed system is a system that the government of United States have adopted to ensure that it have control over the economy. It generally takes three policies; they are open market operations, interest rates, and reserve requirements.
Ambachtshee, K., Beartty, D., & Booth, L. (2008). The Financial Crisis and Rescue. What Went Wrong? Why? What Lesson Can Be Learnt? Toronto: university of Toronto
Broz, J.L. (1997). The International Origins of the Federal Reserve System. New York: Cornell University Press.
Dhameja, N. (2010). Global Financial Crisis: Impact, Challenges & Way-Out. Indian Journal of Industrial Relations, 45(3), 336-349.
Epstein, L., & Martin, P. (2003). The Complete Idiot’s Guide to the Federal Reserve. Indiana: Alpha Books.