The Federal Reserve: The US Money And Banking System

Superior Essays
It is often said that money makes the world go round. Money plays an important role in a country’s economy. Citizens must have money in order to spend money. Governments can help banks create money. In the United States (US), the Federal Reserve is responsible for controlling the money supply to keep the economy running smoothly. One must fully understand the US money and banking system to fully grasp the money market. Knowledge of items that serve as money, the effects of actions taken by the Fed to the economy, steps the Fed can take to increase the money supply, and causes for too little money or spending in a recession are important in attaining proper comprehension of the US monetary system.
In today’s world, money is used to purchase
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“Open market purchases increase the money supply; open market sales decrease it” (Pearson, n.d.). Open market purchases occur when the Fed buys government bonds in order to increase the supply of money. For example, the fed purchases a large amount of bonds from the private sector. The party selling the bonds is given a check for the amount purchased. “Checks written against the Fed count as reserves for the bank” (Pearson, n.d.). The Fed sets the reserve ratio for all banks to retain a percentage of deposits. For instance, if the reserve ratio is set at 10%, banks must reserve 10% of all deposits. The remaining 90% is available for loans. If the reserve ratio is indeed 10% in the previous scenario, 90% of the Fed’s check is added to the supply of money available to the public. This is just one of the tools available to the Fed to increase the supply of money in the economy. The Fed cannot take this ability lightly. “The Fed has unlimited ability to create money. It can write checks against itself to purchase the government bonds without having explicit “funds.” Banks accept it because these checks count as reserves for the bank” (Pearson, n.d.). This ability has the potential to be devastating if used improperly. The system could be manipulated because the entire money market of the US can become a shell game. The Fed can basically “float” a check …show more content…
Recessions can be caused by too little money supply or too little consumer spending. Government officials can utilize monetary policy, fiscal policy, or a combination of the two to improve the economy in order to end the recession. If it is determined there is not enough money available, monetary policy can help correct the problem. The Fed could lower the discount rate. “This, in turn, leads banks to lower the interest rates they charge their customers. And since people are more willing to make a major purchase when they can borrow money at 5%, rather than 7%, individuals are encouraged to borrow and spend more, and businesses are encouraged to invest and expand” (Shmoop Editorial Team, 2008). The Fed could lower the reserve rate, thereby giving banks more flexibility to lend money. Last, but not least, the Fed could make open market purchases to increase the money supply. If government officials determined the problem is due to fiscal policy (too little spending), there are adjustments that can be made as well. Higher taxes and low government spending can contribute to low spending in the economy. Fiscal policy is better equipped than monetary policy at ensuring more money gets into the hands of the consumer. By lowering taxes, consumers immediately get more money in their pay. More money means more consumption. Consumers then have the

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