Us_Federal_Reserve's_Monetary_Policy

US Federal Reserve’s Monetary Policy US Federal Reserve’s Monetary Policy On December 23, 1913, two days prior to Christmas, Congress passed the Federal Reserve Act. One hour later President Thomas Woodrow Wilson signed the bill into law (Krautkramer, 2004). With the signing of the bill, the United States established 12 Federal Reserve banks throughout the United States. The Federal Reserve Act created an independent system designed to stabilize and maintain an elastic economy by regulating monetary policies. Aside from the monetary policies, the Federal Reserve has other duties that include the “transfer of funds, handling government deposits … supervising and regulating banks” (Federal Reserve System, 2007/2008, p. 420). Purpose and Function of Money (words of 175 each) The term Money “is the set of assets in the economy that people regularly use to buy goods and services from other people” (Mankiw, 2007, p. 642). Money serves three functions in the economy. Money is said to be the medium for exchange of products and services, acts as an account, and a store of value. Medium As a medium of exchange, money primarily functions as the means in which business transactions take place daily between people and businesses. When purchasing a product or service the person transfer money from his or her possession to the seller. For example, a person wants to purchase a new suit. The price of the suit is 100 dollars. The buyer will hand the seller of the suit 100 dollars, thus the medium of exchange for the suit is complete. Unit of Account As a unit of money functions as the measurement of value, cost of goods, services, and assets. This allows people to observe and interpret the price, cost, or profits for a service or product. A five dollar bill has many possibilities to divide into smaller units of measurement; for example, two 50 dollars bills, 100 one dollar bills, and five 20 dollar bills, still equals 100 dollars. No matter how a person divides the money, the value remains as 100 dollars. This is what enables people to measure a unit of money. In the example above the person purchased a suit. Here, the person can choose to exchange any number of denominations to reach the 100 dollars. A unit also enables the purchaser to compare the price of the suit to the cost of pants, shirts, or other items for comparison and determine the value of the purchase. Store of Value As a store of value money functions as means to purchase something later. As long as money retains its value, people can retain or store money for later use. One example includes storing money in a savings account. The account holder stores his or her money in a bank, and has certaainties that value of the dollar will maintain its value. However, when inflation affects the economy, the value of the dollar will diminish and the value of dollar will have less purchasing power. Central Bank The Federal Reserve System for the United States is the Central Bank, often called the Fed. The Federal Reserve creation started after several bank failures in 1907 (Mankiw, 2007). The objective for forming the Federal Reserve System ensures the “balance and financial needs of the country” by regulation of banks and monetary policies. The Federal Reserve Bank of San Francisco (2010) states, Money and credit are the lifeblood of the economy; they facilitate commerce, job creation, and business growth. As our [sic] nation's money manager, the Fed implements monetary policy to manage the flow of money and credit in the economy. As our nation's money manager, the Fed conducts monetary policy to attempt to balance these two extremes to keep prices steady, workers employed, and factories productive” (para. 3). The Central bank uses two monetary policies to increase or decrease the circulation of money. The first is cotractionary monetary policy. This part of the monetary policy reduced the quantity on money in the economy by increasing the Federal Reserve ratio, and the selling of government bonds. Contractionary primary purpose it to assist the economy by reducing the speed of growth within the economy. The second monetary policy is expansionary. Expansionary monetary policy increases the circulation of money in the economy, and promotes growth of the economy. Expansionary policy is especially helpful in times of recessions and depressions. During these times the Federal Reserve will decrease the reserve ratio, and buy government bonds. Recent Monetary Policy For the last few years the economy suffered tremendously. Millions of people lost their jobs as companies filed for bankruptcy, moved their company to a foreign county or closed their doors. Because of inflation and the instability in the economy, the Federal Reserve System recently approved financial bail-outs for several banking institutions. American International Group (AIG) Inc. lost approximately 18.6 billion dollars in its investment portfolios, Bank of America 1.8 billion loss for the fourth quarter, and Merill lynch reported a net loss of 15.3 billion dollars (Board of Governors of the Federal Reserve System, February 05, 2110, p.1). One Policy Action Under the Emergency Economic Stabilization Act of 2008, the Federal Reserve approved an extension of money to assist these banks on March 2, 2009. Over the last year the economy experienced many financial stresses and burdens. Using monetary policies in this situation ensures the protection of pension funds, private investments, health insurance, protects the 401(k) retirement plan, and aids in stabilizing the economy (Board of Governors of the Federal Reserve System, February 05, 2110, pp. 1-3) Monetary Policies Effect Production and Employment The economy has thousands of private and public firms that provide goods and services to millions of people. The raising and lowering of an interest rate profoundly affects the demand and supply of goods and services. When the Federal Reserve manipulates the supply of money into the economy; interest rates, inflation, and level of unemployment change. These changes under the Monetary Policy affect the behavior of bushiness and individual decisions daily. The government uses taxes and interest rates to help control the economy. Raising taxes leads to higher unemployment, less efficiency economy, and a reduction in production by industries for goods and services. These goods and services cost considerable more when the interest rate increase and less when the interest rate declines. Interest rate adjustments under monetary policy can be devastating to production. When interest rates increase rapidly, credit becomes harder to obtain, the circulation of cash diminishes, production decreases, and unemployment increases. However, when interest rates are lower, circulation of money in the economy increases, banks are more willing to lend money, production increases, and employment rises. Conclusion The Federal Reserve Act created an independent system designed to stabilize and maintain an elastic economy by regulating monetary policies. Over the last few years the Fed attempted to stabilize a suffering economy. Too often when the government attempts to vitalize the economy it does not turn out as planned. Anyone who studies the current condition of the nation’s economy could conclude that as long as the government continues to spend more public money than it takes in, the economy will continue to suffer despite all the its fiscal and monetary programs ran by the Federal Reserve. References Board of Governors of the Federal Reserve System. (February 05, 2110) retrieved February 07, 2010 from http://www.federalreserve.gov/ Federal Reserve Bank of San Francisco. (2010) The Nation’s Central Bank. The Federal Reserve System is the Central Bank of the United States. Retrieved February 06, 2010 from: http://www.frbsf.org/publications/federalreserve/fedinbrief/central.html Federal Reserve System. (2007/2008). United States Government Manual, 418. Retrieved February 07, 2010 from: http://web.ebscohost.com/ehost/pdf'vid=1&hid=108&sid=b88f1ba8-161e-4a97-ba5e-cb5039a37a91%40sessionmgr110 Krautkramer, Wayne (September 14, 2004) The Federal Reserve – Its origins, History & Current Strategy. Retrieved February 05, 2010 from: http://news.goldseek.com/GoldSeek/1095269452.php Mankiw, N. G. (2007). Principles of Economics (4th ed.). Mason, OH: Cengage Learning.