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Role of Federal Reserve

Essay by review  •  March 19, 2011  •  Essay  •  587 Words (3 Pages)  •  785 Views

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Many countries around the world have central banks that are responsible for transaction with country's national reserves, supervising and regulating other banks and controlling their monetary policies. US Federal Reserve is similar with other central banks but it also has its unique differences. The Federal Reserve is a quasi-governmental and, unlike many of the world's central banks, is a decentralized central bank ("Federal Reserve," 2006). It had power to come up with own decisions and action, though it has to report to congress about them. Main Fed's responsibilities include setting the discount rate, and the reserve ratio, implementing monetary policy by open market operations, control the amount of currency that is made and destroyed on a day to day basis, and maintain consistent payments system ("Federal Reserve," 2006).

Three tools that Federal Reserve uses to control the economy that grows too quickly or too slow are changing interest rate, changing its reserve requirement, and conducting its open market operations.

To cool off overheated economy, the Fed might raise the discount rate. If the discount rate is raised, then banks would borrow less and subsequently have less money available for making loans to general its clients. It would follow into a situation where businesses and consumers would also cut back on spending ("Freedom Investments," 2002). By increasing its reserve requirement Federal Reserve can also decrease funds that are available for borrowing which could force the economy to slow down. Conducting open market operations Fed can control currency flow. When it sells government bonds to other banks it decreases amount of currency that is in circulation.

To speed up the economy Federal Reserve would decrease its discount rate and reserve requirement. It would also purchase government bonds so banks have more funds available for borrowing. Above-mentioned actions could give a jump start for a slow economy and support its growth. Let's bring our economy in past 4 years as an example. Because of the low interest rates, housing market started to grow in great speed. Because firms and individuals had more funds available productions and economy growth was increasing at rapid page. About a year and a half ago Federal Reserve had started to raise its discount rate by a quarter of a point about every 6 months. The result is - housing market had slowed down as well

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