United States Federal Reserve System: The Federal Essay

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United States Federal Reserve System:

The Federal Reserve System or the Fed was established by President Wilson in December 1913 to promote the development of a stable, flexible, and safer financial system in the country. President Wilson enacted the Federal Reserve Act, which was a conclusion of the findings of a commission that was mandated with the task of examining the 1907 severe bank panic. Since its inception, the Federal Reserve System has served as the gatekeeper of the U.S. economy and the country's central bank. Furthermore, this financial institution regulates other monetary institutions, affects the economy, and controls America's money. The Fed achieves its functions by carrying out various activities that either slows down or stimulate the economy. The main duties of the Fed include conducting U.S. monetary policy, offering financial services and liquidity, and supervising and regulating banks.

Federal Reserve and the Discount Rate:

Discount rate can be described as the interest banks pay when they borrow finances urgently and directly from one of the Federal Reserve banks (Kennon, n.d.). Since the Fed has the ability to affect the direction of interest rates, it also adjusts the discount rate based on a consideration of various factors. Some of the factors that influence the Federal Reserve in adjusting the discount rate include the state of the economy, increase or decrease of money supply, borrowing by commercial banks, and banks' lending activities. The other factor that affects the adjustment of the discount rate by the Fed is the probability that the economy is likely to undergo a recession. While this is not a common factor, it forces the Federal Reserve to decrease the discount rate and establish expansionary fiscal policy. However, inflation can also contribute to adjustments in the discount rate since the likelihood of higher inflation forces the Fed to increase the discount rate and establish contractionary financial policy.

The Discount Rate and Bank Specific Interest Rates:

The discount rate plays a significant and wider role in the overall fiscal policy because it's a vivid announcement of changes in the Federal Reserve's monetary policy.

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While higher discount rates are indicators of more restraining financial policies, lower rates are signals of less limiting policies. Due to its importance in the economy, the discount rate has a significant impact on decisions of banks in establishing their specific interest rates. Changes in the discount rate not only affect the economy's open market interest rates but they also affect lending rates. The effect on the lending rates either makes it more or less costly for banks to obtain money to lend or hold. Through decreasing or increasing the discount rate, the Federal Reserve System can encourage or discourage borrowing, which in turn changes the revenue banks can obtain for making loans.

Monetary Policy and Inflation:

Inflation is usually a by-product of increases in the supply of money at a faster rate than the underlying economy. On the other hand, monetary policy can be regarded as the process of increasing or decreasing the supply of money. As a result, monetary policy has a significant impact on inflation and demand for goods and services in the entire economy ("How Does Monetary Policy Influence Inflation and Employment?" 2013). Therefore, monetary policy influences the financial conditions experienced by businesses and households.

The significant impact of monetary policy on inflation is evident when the federal funds rate is minimized, which contributes to stronger demand for goods and services. This increases wages and other costs, which is an indication of the huge demand for materials and employees that are needed for production. Generally, monetary policy seeks to avoid inflation through keeping the money supply stable.

Monetary Policy and Money Supply:

Since monetary policy basically involves increasing or decreasing the supply of money in an economy, it is generally used to control money supply. The Federal Reserve uses three major elements to control….....

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