Complexities of the US Financial System

Financial system serves as the economic backbone of the country. Financial markets provide capital to businesses, and home owners and a safe haven for income. The financial system includes a variety of financial institutions (different types of banks, for example) as well as the central bank, the stock market and other peripheral types of businesses like mutual funds. For individuals, the system provides a safe place for deposits, and access to capital for things like mortgages, college education or cars. For businesses, banks are a critical source of investment capital that is used for expansion. Thus, the financial system allows for our economy to grow, and for consumers to be able to afford to live better. For the economy, it is critical to have a robust financial system. When the financial system is weakened, as happened in 2008, the results for the economy can be devastating (Levine, 2010). This is one of the reasons why the Federal Reserve has instituted stress tests for financial institutions to maintain their integrity (Reuters, 2013).

The Federal Reserve is the central bank for the United States, charged with governing the banking system, as well as providing liquidity to capital markets. The Chairman of the Federal Reserve, currently Ben Bernanke, is the chief policy maker of the bank and its most influential person. However, there are twelve Federal Reserve banks within the Federal Reserve system, and each has a governor. The Board of the Federal Reserve is one of its key policy-making bodies, along with the open market committee.

The Federal Reserve is charged with monetary policy in the United States. It typically does this through three means- the discount rate, open market transactions and reserve requirements. The Fed has for the past several years been engaging in expansionary monetary policy, with very low interest rates, and using both conventional and unconventional monetary policy to attempt to spur economic growth. The size of the slump was severe, and Fed policy has done little for the economy to gain traction -- there is still surplus demand in the economy so little impetus for business investment no matter how much cheap money is available. The lack of economic growth in that period is less an indictment of Fed response as it is an illustration of the limits of monetary policy alone to tackle major economic downturns.

Interest rates have been persistently low in the United States. This is expansionary policy because the lower the cost of money, under normal circumstances the higher the demand for money. This is because the expected present value of future cash flows is higher than the cost of capital for firms. Normally, such low rates would create a spike in business investment and in consumer borrowing, leading to a robust economy, even to the point of creating inflationary pressure. Ordinarily, a booming U.S. economy would be beneficial for countries around the world, as their trade would also increase. Unfortunately, the U.S. economy remains depressed -- the money is there but a lack of demand means that the money is still on the sidelines. The U.S. domestic market is growing slowly and major customers like Europe are not growing at all.