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Federal Reserve System Essay

The United States has successfully applied monetary policies in fostering its economic growth and development. This however did not come up easily but involved a long process that was finally sealed by the establishing of the Federal Reserve System. The country’s main concern was to come up with a system that harmonizes the supply of common banknotes that would increase security in the banking sector and increase investor confidence. Such a banking sector would be stable and flexible to accommodate any necessary adjustments that would be inevitable for prosperity and growth of the America’s economy.

This paper therefore examines the Federal Reserve System and its tools that are employed to expand or contract the America’s economy using money supply and interest rates(Wells D. R, 2004, pp. 7-29). In the history of the United States, there has been three banking system; first bank that existed between the year 1791 and 1811, the second was between 1816 and 1836. These two banks were responsible for the banking and issuing money in the U. S. and therefore represented U. S treasury. There were other banks which issued their own money and created competition with the first and the second U.

S banks. They were however private entities whose operation was under the state chatter. With the increase in population, economic activities and migration, there was chaos among the competing banks and their banknotes. This led to the formation of national banks in 1863 after the enactment of ‘the first national bank act’ which was intended to regulate the banks’ loaning systems, liquidity ratio and elimination of non-federal currency through imposition of a 10% tax ‘on state banknotes’.

Lack of elasticity, security and economically stable banking system led to the 1907 panic that called for immediate reforms in currency and banking institutions at large. As a result Aldrich-Vreeland Act was passed with two objectives; first was to come up with a currency that would be used for emergency purpose to quell down the situation and secondly, to establish a national monetary commission that would foresee the necessary reforms in the banking sector.

This was followed by enactment of the Federal Reserve act in the year 1913 in order to boost the economic growth both domestic and abroad which led to the formation of the Federal Reserve System(Wells D. R, 2004, pp. 7-29; http://usgovinfo. about. com/library/weekly/aa081599. htm ). Fed is unique among central banks in that it is not only a government entity but also quasi-private. It has private components unlike other central banks, in other words, it is quasi-public and at the same time it is quasi-private.

Its structure is very unique in that in comprises of a federal agency representing the government, board of governors who are based in Washington and in 12 other regions in the country (http://usgovinfo. about. com/library/weekly/aa081599. htm ). The fed employs the following expansionary and contractionary tools using money supply and interest rates. First is the open market operation. This involves the use of federal securities as monetary policy. Selling of these securities mops excess money from banking system and the selling of the securities increases money supply.

This dictates the federal funds rate and regulates bank reserves’ supply. It also involves repos which are short-term transactions that help to inject and withdraw money into the system in short term intervals when need arises. It also uses discount rates where increasing of these discount rates will lead to increase cost of loans and reduces money in circulation. Reducing the discount rate will reverse the trend. This reduces and increases borrowing of money from financial institutions respectively.

During emergencies, the fed may use discount windows as it was the case of September 11th incident. This enables the banks to access more money that they can lend to those people in need. The reserve requirement is also another tool that the fed uses. This is the money that a banking institution should maintain with the Federal Reserve Bank. Increasing the amount will mop excess money from circulation and vice versa (Shim J. K, Siegel J. G, 2005, pp. 106-109; http://usgovinfo. about. com/library/weekly/aa081599. htm ). Conclusion

This Federal Reserve System has been successful in the sense that it has been able to achieve most of its main objectives. Use of contractionary and expansionary tools has fostered economic development and stability. It is as a result of this that many countries have emulated the federal system in their central banking systems and have yielded good fruits. Though some people may point some weaknesses in the Federal Reserve System, the truth is that it has brought the economy of the U. S to the far it is and it has altogether been successful.

Future improvements in the system would perhaps drive the America’s economy to even greater heights (Shim J. K, Siegel J. G, 2005, pp. 106-109; http://usgovinfo. about. com/library/weekly/aa081599. htm ). References Amadeo K, THE FEDERAL RESERVE SYSTEM; HISTORY, FUNCTION & ORGANIZATION, Retrieved from http://usgovinfo. about. com/library/weekly/aa081599. htm on 22nd may, 2009 Shim J. K, Siegel J. G, (2005), Macroeconomics, 2nd Edd, Barron’s Educational Series (pp. 106-109) Wells D. R, (2004), The Federal Reserve System: a history, McFarland (pp. 7-29)

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