The Federal Reserve System Essay example

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Theory Monetary policy is a process a central monetary authority employs to achieve certain macroeconomic objectives. In the United States the central monetary authority is the Federal Reserve (Fed). The Fed uses several methods to achieve two main, though not exclusive, goals: expanding the economy and reducing inflation. When the Fed wishes to expand the economy, it employs a policy called expansionary monetary policy. When it wishes to combat inflation, it employs a policy called contractionary monetary policy. The first part of this paper will detail the reasons for the existence of monetary policy, reveal the tools that the Fed has at its disposal to achieve its ends, present the mechanics of the two main methods in monetary policy, …show more content…
In other words, the Fed would try to reduce unemployment, push for an increase in production, and lower inflation to increase purchasing power. The tools the Fed has at its disposal are numerous. The Fed can buy and sell government bonds (called open market operations), set reserve requirements, and act as the lender of last resort for banks. Open market operations serve two purposes: to expand and shrink the money supply. When the Fed sells bonds, it is trying to shrink the money supply. When it buys bonds, it is trying to expand the money supply. The reserve requirement is the minimum amount of money a bank must have in its vault in order to pass regulatory standards. The requirement is set by the Fed. When the reserve requirement is low, the banks are able to loan out more (per the multiplier), essentially allowing the banks to take more risks. When the reserve requirement is high, the banks have to tighten their lending practices and are therefore able to loan out less. When a bank fails to meet the reserve requirement is is either shut down or it requests to loan money from the Fed (hence being the “lender of last resort”). The Fed charges the banks an interest rate called the discount rate. The interest rate the Fed charges is usually higher than those charged from bank to bank, so banks tend to avoid borrowing from the Fed at all costs. These three tools are used by the Fed to achieve its goals via expansionary and

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