Every Capitalist nation has a monetary system basically similar to ours. As a consequence, all have developed central banks whose duties are essentially like those of the Federal Reserve, namely, to exert control over the direction and extent of changes in the money supply.
The aim of all central banks is also the same. They want to keep their economies supplied with the “right” amount of money. If money supplies are scarce, the economy will suffer as if it were in a straitjacket. Households and business alike seeking in vain for credit from their banks, and householders and business alike contracting their economic activity as a result. If money supplies are too large, householders, and businesses will find themselves with larger bank accounts than normal, and will be tempted by their liquidity, or by the low interest rates offered by their banks, to increase their spending.
This would seem to make the task of the Federal Reserve rather easy. All it has to do is to take the temperature of the economy and adjust the amount of money accordingly. If the economy is “overheated,” with inflation or worsening, clearly it is time to cut back on the availability of money. If the economy is in a depression, with unemployment rising, just the contrary must be the proper course. It sounds, therefore, as if the job of the central banker is an easy one. As we shall see, it is not.
How does a central banker increase or decrease the supply of money? The key lies in the fact that we have a fractional reserve system in which banks can make loans or investments with “excess” reserves. Excess reserves are simply cash or deposits at the Fed that are greater than those required by law to back up their customers’ deposits.
The Essay on Money Growth Rule Economy Supply Inflation
... Fitzgerald, an economist at the Cleveland Federal Reserve Bank, if one defines money supply as M 2, when examining the data ... in relative output, the money supply can have dramatic effects upon the economy. Additionally, by establishing a money growth rule, Friedman ... central banker. The problem with human intervention is the short-sided nature of many of the policies designed to aid the economy. ...
Essentially, the Federal Reserve is a system designed to raise or lower the reserve requirements from its member banks. When it raises the reserves, it squeezes its members, who find that they have less free reserves to lend or invest. When the Fed lowers requirements, just the opposite occurs, and member banks are able to lend or invest more of their reserves, thereby making more profit for themselves.
Actually, there are three ways in which the Fed can act. The first is by directly changing the reserve requirements themselves. Because these new reserve requirements affect all banks, changing reserve ratios is a very effective way of freeing or contracting bank credit on a large scale. But because it sweeps across the banking system in an undiscriminating fashion it is used only on rare occasions.
A second means of control uses interest rates as the money-controlling device. Member banks that are short on reserves have a special privilege, if they wish to exercise it. They can borrow reserve balances from the Federal Reserve Bank itself and add them to their regular reserve accounts at the bank.
The Federal Reserve Bank, of course, charges interest for lending reserves; this interest is called “discount rate.” By raising or lowering this rate, the Federal Reserve can make it attractive or unattractive for member banks to borrow or augment their reserves. Thus, in contrast with changing the reserve ratio itself, changing the discount rate is a mild device that allows each bank to decide for itself whether it wishes to increase its reserves. In addition, changes in the discount rate tend to influence the whole structure of interest rates, either tightening or loosening money. When interest rates are high, we have what we call “tight money.” This means not only that borrowers have to pay higher rates, but that banks are stricter and more selective in judging the creditworthiness of business applications for loans. Conversely, when interest rates decline, money is called “easy”, meaning that it is not only cheaper but also easier to borrow.
The Essay on Federal System Reserve Banks Bank
central banking system of the United States. Established in 1913, it began to operate in Nov. , 1914. Its setup, although somewhat altered since its establishment, particularly by the Banking Act of 1935, has remained substantially the same. Structure The Federal Reserve Act created 12 regional Federal Reserve banks, supervised by a Federal Reserve Board. Each reserve bank is the central bank for ...
Although changes in the discount rate can be used as a major means of controlling the money supply and are used to control it in some countries, they are nit used for this purpose in the United States. The Federal Reserve Board does not allow banks to borrow whatever they would like at the current discount rate. The discount “window” is a place where a bank can borrow small amounts of money to cover a small deficiency on its reserves, but it is not a place where banks can borrow major amounts of money to expand their lending portfolios. As a result, the discount rate servers more as a signal of what the Federal Reserve would like to see happen than as an active force in determining the total borrowing of banks.
By far the most frequently used is a third technique called open-market operations. This technique permits the Federal Reserve banks to change the supply of reserves by buying or selling U.S. government bonds on the open market.
How does this work? Let us suppose that the Federal Reserve authorities wish to increase the reserves of member banks. They will begin to buy government securities from dealers in the bond markets, and they will pay these dealers with Federal Reserve checks.
Notice something about these checks. They are not drawn on any commercial bank! They are drawn on the Federal Reserve Bank itself. The security dealer who sells the bonds will, of course, deposit the Federal Reserve’s check as if it were any other check, in his or her own commercial bank; and his or her bank will send the Federal Reserve’s check through for credit to its own account, as if it were any other check. As a result, the dealer’s bank will have gained reserves, although no other commercial bank has lost reserves. On balance, then, the system has more lending and investing capacity than it had before. Thus, by buying government bonds the Federal Reserve has, in fact, deposited money in the accounts of its members, thereby giving them the extra reserves that it set out to create. This is what is meant by “monetizing” the debt.
The Essay on The Federal Reserve Bank
The Federal Reserve Bank (Fed) was created to reduce the risk of a repeat of the financial panics that occurred in the United States before its creation in 1913. The official objective of the Fed is to ensure the financial strength and stability of the nation's banking system. The Fed regulates and examines the nation's depository institutions to reach its objective. Also, it serves as a central ...
Conversely, if the monetary authorities decide that member banks’ reserves are too large, they will sell securities. The U.S. Treasury notes that make up part of the assets of the Federal Reserve Banks. Now the process works in reverse. Security dealers or other buyers of bonds will send their own checks on their own regular commercial banks to the Federal Reserve in payment for these bonds. This time the Fed will take the checks of its member banks and charge their accounts, thereby reducing their reserves. Since these checks will not find their way to another commercial bank, the system as a whole will have suffered a diminution of its reserves. By selling securities, in other words, the Federal Reserve authorities lower the Federal Reserve accounts of member banks, thereby diminishing their reserves.
Thus we see that there are three ways in which the Federal Reserve can increase or decrease the money supply. It can raise or lower bank reserves. Moreover, it can raise or lower the discount rate, and it can sell or buy government bonds.
