In this essay I will discuss the role of the Federal Reserve in the United States economy. In doing this I will look first at open market operations as a tool to influence money supply. Then, I will look at discount rate and federal funds target rate and how the Federal Reserve uses it to influence money supply. Lastly, I will look at required reserve ratio and deposit expansion (money) multiplier as a tool the Federal Reserve uses to influence the money supply. Throughout discussion of these concepts I will give my opinion on how the Federal Reserve might best employ each of these tools given to our certain economic situation which would be to lower money supply to avoid inflation.
The Federal Reserve System, also known as the Fed, is the United States central bank and is responsible for all other banks in the US and for the amount of money we have in the economy. The Fed is run by a board of seven governors that are appointed by the president and then approved by the Senate. The main reason we are concerned about how the Fed's effect the economy is because it has the ability to set the rates for interest and also can effect inflation. It can lower or raise inflation with monetary policy and raise or lower interest rates. Now we will look at how the Fed uses open market operations as a tool to influence the money supply.
Open market operations is when the Fed purchases or sells US bonds. The Fed uses open market operations most often because it is an easy way to effect the money in the economy without having to change any banking regulations or laws. In a single day the Fed can effect the money supply by having the New York branch of the Federal Reserve buy or sell bonds in the US bonds market. The way that the Fed increases the money supply within the economy is to get the New York bond traders to buy up US bonds. The money that the Fed spends on bonds, causes more money to be funneled into the economy. Of the money added to the economy, some is held as currency while others is deposited into banks, which causes the supply of money to be raised in both cases. You can see how doing this greatly effects the amount of money in the economy on any given day. On the contrary, by selling bonds, the Fed can lower the amount of money in the economy by selling bonds to the general public which causes the banks to have less money and therefore lowers the amount of money disseminated throughout the economy. It also means that banks have less money in their reserves which means less loans are given out. I think the best way for the Fed to help the current economy is to decrease the money very carefully by slowly selling US bonds and decreasing the amount of money in circulation and hopefully stimulating the economy through real money, not money from loans.
When we look at how banks borrow money, there are two options for them. The first is the discount rate and is what the Fed charges bank to borrow directly from them. The discount rate is used to...