Federal_Reserve

Federal Reserve The Federal Reserve and money go hand in hand. This essay will define the purpose and function of money and explain how the central bank manages a nation’s monetary system. The direction of recent monetary policy in the United States and at least one policy action that the Federal Reserve has taken to confirm that direction will also be presented as well. Lastly, this essay will explain the effects of monetary policies on the economy’s production and employment. The purpose of money is to make trading easier. Money has three functions in the economy: It is a medium of exchange, a unit of account, and a store of value. These three functions together distinguish money from other assets in the economy, such as stocks, bonds, real estate, art, and even baseball cards. A medium of exchange is an item that buyers give to sellers when they purchase goods and services. A unit of account is the yardstick people use to post prices and record debts. A store of value is an item that people can use to transfer purchasing power from the present to the future. The central bank is an institution designed to oversee the banking system and regulate the quantity of money in the economy. One institution is called the Federal Reserve aka The Fed. The Fed has two related jobs. The first is to regulate banks and ensure the health of the banking system. This task is largely the responsibility of the regional Federal Reserve Banks. In particular, the Fed monitors each bank’s financial condition and facilitates bank transactions by clearing checks. The Fed also acts as a bank’s bank. That is, it makes loans to banks when banks themselves want to borrow. When financially troubled banks find themselves short of cash, the Fed acts as a lender of last resort—a lender to those who cannot borrow anywhere else—to maintain stability in the overall banking system. The Fed’s second and more important job is to control the quantity of money that is made available in the economy, called the money supply. Decisions by policymakers concerning the money supply constitute monetary policy.At present, the focus of monetary policy is on stimulating economic activity in order to limit the degree to which the economy falls short of full employment and to prevent a sustained decline in inflation below levels consistent with the Federal Reserve's legislated objectives. Despite continued large holdings of assets, the Federal Reserve will have at its disposal two broad means of tightening monetary policy at the appropriate time. The first method for tightening monetary policy relies on the authority that the Congress granted to the Federal Reserve last fall to pay interest on the balances maintained by banks. The second method for tightening monetary policy, despite a high level of assets on the Federal Reserve's balance sheet, is to take steps to reduce the overall level of reserve balances. Raising the rate of interest on reserve balances and draining reserves through the options just described would allow policy to be tightened even if the level of assets on the Federal Reserve's balance sheet remained very high. In short, the Federal Reserve has a wide range of tools that can be used to tighten the stance of monetary policy at the point that the economic outlook calls for such action.The Federal Reserve and other government entities implemented additional policy initiatives to support financial stability and promote economic recovery. Federal Reserve initiatives included expanding direct purchases of agency debt and agency mortgage-backed securities (MBS), beginning direct purchases of longer-term Treasury securities, and providing loans against consumer and other asset-backed securities (ABS).1 Other government entities also undertook new measures to support the financial sector, including the provision of more capital to banking institutions under the Capital Purchase Program, or CPP, and the announcement of programs to help banks manage their legacy assets. In addition, the bank supervisory agencies undertook a special assessment of the capital strength of the largest U.S. banking organizations (the Supervisory Capital Assessment Program, or SCAP). Changes in real interest rates affect the public's demand for goods and services mainly by altering borrowing costs, the availability of bank loans, the wealth of households, and foreign exchange rates. For example, a decrease in real interest rates lowers the cost of borrowing; that leads businesses to increase investment spending, and it leads households to buy durable goods, such as autos and new homes. Lower real interest rates in the U.S. tend to reduce the foreign exchange value of the dollar, which lowers the prices of the U.S.-produced goods we sell abroad and raises the prices we pay for foreign-produced goods. This leads to higher aggregate spending on goods and services produced in the U.S. The increase in aggregate demand for the economy's output through these different channels leads firms to raise production and employment, which in turn increases business spending on capital goods even further by making greater demands on existing factory capacity. It also boosts consumption further because of the income gains that result from the higher level of economic output.Understanding the U.S. Federal Reserve’s monetary policy can broaden your outlook of the central bank and how it controls money. The economy is consistently changing and learning the monetary policy gives a clearer view of how directly it affects our economy as a whole function.