Federal Reserve System Term Paper

  • Length: 5 pages
  • Subject: Economics
  • Type: Term Paper
  • Paper: #42991633

Excerpt from Term Paper :

Federal Reserve System is.

The Federal Reserve System

The Federal Reserve serves as the central bank of the United States. It was founded by the Congress in 1913 to serve the function of provide the nation with a secure and committed monetary and financial system.

Today the Federal Reserve holds the responsibilities in four areas: (1) conducting the nation's monetary policy; (2) supervising and regulating banking institutions and protecting the credit rights of consumers; (3) maintaining the stability of the financial system; and (4) providing certain financial services to the U.S. government, the public, financial institutions, and foreign official institutions.

The Federal Reserve System is controlled by the Board of Governors of the Federal Reserve System who formulate the initial margin requirements under Regulations T, U, and X. Margin loan increases and decrease in aggregate value and relative to market capitalization, affect margin requirements instrumentally affecting the prices of common stocks. Proponents of margin requirement policy see the affects of the regulations affecting the level and instability of stock prices by manipulating the investors' demand for stocks.


The Federal Reserve System has been the central bank of the United States since 1913. The purpose of a central bank is to control the supply of money and credit to the economy. The Board of Governors is the main principal policy-making organization in this process.

The board comprises of seven members, two of who are appointed as chairman and vice chairman. Each governor serves a fourteen-year term, while the chairman and vice chairman serve four years. The president is in charge of appointing all the seven governors in confirmation with the Senate, as well as appointing the chairman and vice chairman. The terms served by the Federal Reserve governors are rather long being second to lifetime appointments of federal judges to protect the members from political pressures and independent decision-making.

Regulating the nation's money supply requires the Federal Reserve to control the amount of reserve funds for banks and also the level and focus of short-term interest rates. The Federal Reserve decides whether banks and other financial institutions can make loans depending on the profit margin and on the difference in the rate of interest that must be paid to draw deposits or take funds on the interest rate that can be charged from customers for credit. The principle of this is that the greater the profit margin banks can charge on new loans, the more they are to allow loans. To see the affect of the interest rates on deposits and interest rates that banks pay to borrow funds, the Fed uses the authority given to them through the congress to create money.

The Fed creates money in three ways. The first method is whereby the Fed can buy U.S. government securities from financial institutions by creating credits on their balance sheets swapping for the securities. When these securities are purchased directly from banks, immediately the banks show the new liquid reserves on their books. When financial institutions deposit their earnings from sales of securities, the reserves in banks show an increase. When banks become filled with extra reserves, they provisionally allow these funds to be borrowed by other banks as a method of earning interest overnight. The increased supply of reserves in comparison to the money market causes the overnight interest rate called the federal funds rate to fall considerably. This decline in the cost of credit to banks results in the increase in the profitability of new loans to businesses and individuals and making way for better incentives for banks to expand using the amount of credit to the economy.

Open market operations function to control the money and credit from the Fed purchases and sales of government securities. The Federal Open Market Committee makes all the decisions with the board of governors holding the majority of the votes, in how to manage the open-market operations. The FOMC has twelve voting members: the seven members of the board of governors and five of the twelve presidents of the regional Federal Reserve operating banks. Each voting member has one vote, and to make a change in the policy only a simple majority is needed. FOMC meetings are held after every six weeks to decide the on the amount of reserves to the banking system and the level of short-term interest rates.

The second monetary policy the Federal Reserve has is the discount rate, and the interest rate that the Fed charges on loans made to banks. The Feds can control the borrowing and funding of loans by increasing or decreasing this rate, therefore, allowing more loans to the public. The board of governors sets the discount rate by casting a majority vote, and also considering the suggestions of the directors from the twelve regional reserve banks.

In the past, the discount rate served two purposes; one has been for assisting monetary policy and supplying emergency liquidity to troubled banks. The Fed has faced a debate with trying to achieve two different missions with the discount rate and what is the actual role of the discount rate. It has been decided that to accelerate the growth of credit in the economy through discount rate lending, the Fed set the discount rate below other existing short-term interest rates. This is because if this is not done than banks will show no incentive to borrow from the central bank.

The third way the Fed operates monetary policy is by controlling the proportion of liquid reserves that banks have to keep on hand. This is because the higher the reserve requirement, the fewer funds there will be available to make new loans. The board of governors has the right to establish reserve requirements above the legal minimum for all federally insured financial institutions. Also, reserve requirements can easily be changed by a simple majority vote of the board. In reality, reserve requirements are never really altered because small adjustments result in massive impacts on the quantity of required reserves.

The private banks were able to maintain constant regional reserve bank rates even though they had interference from Washington to centrally manage credit growth. This led to a standardized policy on the discount rate and opened the way for a decentralized Federal Reserve System. It was in the twenties, open-market operations expanded into an approach for monetary policy under Benjamin Strong, head of the Federal Reserve Bank of New York.

The Great Depression in the thirties led the Fed to concentrate more on the central management of monetary affairs. President Roosevelt Franklin along with Marriner Eccles, a Utah banker, legislated the Banking Act of 1935, which made Washington responsible for the authority over the monetary policy with the independent seven-member board of governors, and with no secretary of the Treasury and the comptroller of the currency. Eccles was made the first chairman of this new board. The board held office in a separate building built for their use on Constitution Avenue. Following this Benjamin Strong's open-market group became a permanent Federal Open Market Committee in a provision of the banking act.

The board has the responsibility for the monitoring of the banking system with full authority over monetary policy. This is why in addition to the board's key function of managing U.S. monetary policy, it also has the responsibility of managing all bank holding companies, all state chartered banks that are members of the Federal Reserve System, and international activities of all U.S. banks. Also the board controls U.S. consumer banking laws and margin requirements in the stock market.


The total expenditure of the federal government's statistical system, spends more than $4 billion a year, provides critical information for many federal programs. This information covers population data used for allotment and population distribution; state of the nation's economic performance as used…

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