The Federal Reserve's use of discount rates to control money supply and inflation

United States Federal Reserve System

Factors that influence the Federal Reserve in adjusting the discount rate

Interest rates are charged for loans to commercial banks. In accordance to the rules and regulations of the Federal Reserve, this is a principle that can be used as a means of controlling the money supply. An increase in the level of the money supply is achieved when the Federal lowers the rates of discount. A decrease for money supplied is achieved by raising the amounts of loans issued by the Federal Reserve. The board of governors is subject to scrutiny and approval of the levels of discount rates that are set by the Federal Reserve. The Federal Reserve does not work on its own. It operates under strict guidance from the board of directors within the organization. The decisions made by the board of governors through the Federal Reserve are directed at maintaining the rates of discount and not the amounts of money supplied to the markets. Nonetheless, the Fed makes use of the discount rates in order to monitor the nature of the money supply to the market (Brown, 2008).

How the discount rate affect the decisions of banks in setting their interest rates

The rates of discounts are effectual to the decisions made by the banks. The aims of the banks are directed at making a profit from any way possible. The methods used by the Fed are rudimentary to the amounts of profit made by the banks. For instance, when the Fed increases the interest rates, this forces the banks to up their rates of interest in order to register margins of profit and growth in the market. On the other hand, when the Fed decreases the discount rates, the banks have to adjust to lower rates of discounting with an aim of making reasonable profits from the public and corporate. The control of the rates of interests is the main activity that is monitored by the Federal Reserve. In order to attain an equitable supply of money, the system has to make several considerations that are directed at influencing the rates of interests applied by the banks (Wells, 2004).

From the reserve ratios, banks are expected to keep a given proportion of their deposits as a reserve contrary to the potential withdrawals. The Fed varies the amounts of the reserve ratio in order to control the quantity of money that is under circulation in the country. Through this avenue, the Fed manages to control all the rates of discounts set by the banks in the country.

How the monetary policy control the money supply

The Federal Reserve makes use of the rates of discount in order to control the amounts of money in circulation. The supply of money is a facet that is controlled by the rates of discounts issued by the Federal Reserve. The total amount of money under supply is a function of the discount rates through which the available facets are applied. It is necessary to consider the levels of performances that are accrued to all the rates of discount. Through maintenance of stable state levels of discounts, the Fed manages to keep a balance of the monetary supplies in the market. Through maintenance of a stable level of interest rates, the Federal Reserve maintains the total amount of money that is under circulation (Wells, 2004).

How a stimulus program affect the money supply

The stimulus program is used as an entity that relates the total amount of money supplied to the market and the rates of growth and development of many economies. The monetary supply program is crucial when it comes to controlling the services and directions taken by banks and other organizations. Such directions are those that dictate many monetary performances in the market. In order to foster an equitable state of mainlining monetary supply in the market, the stimulus programs are used as indicators. They indicate possible cases where the country is likely to engage in inflation and recession. Through control of the interest rates together with supply of money, the stimulus is used as an indicator that reflects on the general performance of many monetary parameters without failure.

Indicators that there is too much or too little money within the economy and adjustments made by the monetary policy

The rates of discounts inserted by banks are an indicator that there is too much or too little money under circulation in the economy. For instance, it is possible to have a large sum of money when the rates of discounts appear to be growing low in the market. The rates of discounts are also indicated by the total amount of money received by banks and private organizations in the form of interests. In order to avoid aspects of inflation and recession, the Federal Reserve ensures that it has contained the general precepts of maintaining the interest rates in the economy (Meltzer, 2009).