Summary Of The Federal Reserve's History And Policy Procedures

838 words - 3 pages

Ć The Early Years: Discount as Primary ToolChanging the discount rate was the primary tool of monetary policy when the Fed was created and the Fed had not yet discovered the power of open market influencing money supply. Before WWI, the Fed had taken a passive role the utilized policy following the "real bills doctrine". However, by the end of WWI, Fed's passive policy had led to a raging inflation. As a result, Fed decided to take an active role in influencing the economy and raised the discount rate significantly in 1920, which led to a sharp recession in 1920-1921. Although the Fed was blamed from its action, in one sense the Fed was still successful since it did make the price level declined.Ć Discovery of Open Market OperationsIn the early 1920, Fed accidentally discovered the use of open market operation. When the Fed was created, its revenue came exclusively from the interest it received on the discount loans. However, by the end of the 1920s, open market became the most important weapon to the Fed.Ć The Great DepressionThe stock market boomed in 1928 and 1929. In the beginning, the Fed wanted to temper the boom by raising the discount rate. However, it was reluctant to do so due to its concerns about business and individual that may have credit needs. As a result, when the Fed decided to intervene, it was too late. The stock market crashed and thus led to a recession of the economy. Many banks failed during that time.Ć War Finance and the Pegging of Interest Rates: 1942-1951During WWII, the spending of US government increased sharply therefore the Treasury issued huge amount of debt. The Fed agreed to help the Treasury pegging the low interest rate, which result in a rapid growth of money supply. When the Korean War broke out in 1950, inflation began to heat up, and the Fed decided it was time to reassert its control over monetary policy by abandoning the pegging of interest rate. In 1951, the Fed and the Treasury came to an agreement to abandon the interest-rate peg but the Fed had to maintain interest rate at a low level. The Fed was given complete freedom of its monetary policy in 1952.Ć Targeting Money Market Conditions: The 1950s and 1960sWith freedom, the Fed took the view that monetary policy should be grounded in intuitive judgment based on a feeling for the money market. The Fed used many variables that were supposed to describe the market condition. One of the most noteworthy...

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