The Federal Reserve System

The Federal Reserve System

Why do a research paper on the Federal Reserve System? This is a question we went over in our heads while making a decision on the type of research paper to do, what we wanted to learn more about and why. Over the past few years we have realized the impact that the Federal Government has on our economy, yet we never knew enough about the subject to understand why. While taking this Economics course it has brought so many things to our attention, especially since we see inflation, gas prices, unemployment and interest rates on the rise. It has given us a better understanding of the effect of the Government on the economy, the stock market, the interest rates, etc. Since the Federal Government has such a control over our Economy, we decided to tackle the subject of the Federal Reserve System and try to get a better understanding of the history, the structure, and the monetary policy of the power that it holds.

The Federal Reserve System is the central banking authority of the United States. It acts as a fiscal agent for the United States government and is custodian of the reserve accounts of commercial banks, makes loans to commercial banks, and is authorized to issue Federal Reserve notes that constitute the entire supply of paper currency of the country. Created by the Federal Reserve Act of 1913, it is comprised of 12 Federal Reserve banks, the Federal Open Market Committee, and the Federal Advisory Council, and since 1976, a Consumer Advisory Council which includes several thousand member banks. The board of Governors of the Federal Reserve System determines the reserve requirements of the member banks within statutory limits, reviews and determines the discount rates established pursuant to the Federal Reserve Act to serve the public interest; it is governed by a board of nine directors, six of whom are elected by the member banks and three of whom are appointed by the Board of Governors of the Federal Reserve System. The Federal Reserve banks are located in Boston, New York, Philadelphia, Chicago, San Francisco, Cleveland, Richmond, Atlanta, Saint Louis, Minneapolis, Kansas City and Dallas.

The Federal Open Market Committee, consisting of the seven members of the Board of Governors and five members elected by the Federal Reserve banks, is responsible for the determination of Federal Reserve Bank policy in the purchase and sale of securities on the open market. The Federal Advisory Council, whose role is purely advisory, consists of 12 members if they meet membership qualifications.

The Federal Reserve System exercises its regulatory powers in several ways, the most important of which may be classified as instruments of direct or indirect control. One form of direct control can be exercised by adjusting the legal reserve ratio (the proportion of its deposits that a member bank must hold in its reserve account), and as a result, increasing or decreasing the amount of new loans that the commercial banks can make. Because loans give rise to new deposits, the possible money supply is, in this way, expanded or reduced. This policy tool has not been used too much in recent years. The money supply may also be influenced through manipulation of the discount rate, which is the rate if interest charged by the Federal Reserve banks on short-term secured loans to member banks. Since these loans are typically sought to maintain reserves at their required level, an increase in the cost of such loans has an effect similar to that of increasing the reserve requirement. The classic method of indirect control is through open-market operations, first widely used in the 1920s and now used daily to make some adjustment to the market. Federal Reserve bank sales or purchases of securities on the open market tend to reduce or increase the size of commercial bank reserves. When the Federal Reserve sells securities, the purchasers pay for them with checks drawn on their deposits, thereby reducing the reserves of the banks on which the checks are drawn. The three instruments of control explained above have been conceded to be more effective in preventing inflation in times of high economic activity than in bringing about revival from a period of depression.

Another control occasionally used by the Federal Reserve Board is that of changing the margin requirements involved in the purchase of securities. The Federal Reserve System was founded by Congress in 1913 to provide the nation with a safer, more flexible and more stable monetary and financial system. Over the years its role in banking and the economy has expanded. Today the Federal Reserve's Duties fall into four general areas:

$ Conducting the nation's monetary policy by influencing the money and credit conditions in the economy in pursuit of full employment and stable prices.

$ Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system to protect the credit rights of consumers.

$ Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.

$ Providing certain financial services to the United States government, the public, financial institutions, and to foreign official institutions, including playing a major role in operating the nation's payments system.

Before Congress created the Federal Reserve System, periodic financial panics had plagued the nation. These panics had contributed to many bank failures, business bankruptcies, and general economic downturns. A severe crisis in 1907 prompted Congress to establish the National Monetary Commission, which put forth proposals to create an institution that would counter financial disruptions of these kinds. After much debate, Congress passed the Reserve Act, which was signed into law by President Woodrow Wilson, on December 23, 1913. The Act stated that its purpose was to provide for the establishment of Federal Reserve banks, to furnish an elastic currency, to afford means of discounting commercial paper, and to establish a more effective supervision of banking in the United States, among other things. Soon after the creation of the Federal Reserve, it became clear that the act had broader implications for national economic and financial policy. As time passed, further legislation clarified and supplemented the original purposes. Key laws affecting the Federal Reserve have been the Banking Act of 1935, the Employment Act of 1946, the 1970 amendments to the Bank Holding Company Act, the International Banking Act of 1978, the Full Employment and Balanced Growth Act of 1978, the Depository Institutions Deregulation and Monetary Control Act of 1980, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, and the Federal Deposit Insurance Corporation Act of 1991.