Federal Reserve Essay Research Paper Greenspan and

Federal Reserve Essay, Research Paper

Greenspan and the Federal Reserve: Methods and Resources

The United States of America was founded as a capitalist nation dependent on independent trade by privately owned businesses. This system of economics stays as far away as possible from a centralized government controlled economy. However, as generations of economists, politicians, and businessmen carried out the principles of the Constitution, it became apparent that some centralized bank was required to maintain stability and order in the national economy. This central bank is known as the Federal Reserve, and its Chairman is responsible for maintaining a positive economy through several powers. The current Chairman is Alan Greenspan, a man responsible for controlling a stable economy through several checks and balances.

The Federal Reserve was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. Today the Federal Reserve’s duties fall into four general areas: conducting the nation’s monetary policy; supervising and regulating banking institutions and protecting the credit rights of consumers; maintaining the stability of the financial system; and providing certain financial services to the U.S. government, the public, financial institutions, and foreign official institutions. It consists of twelve regional banks that are owned and controlled by member banks in their region. Overseeing the twelve regional banks is the seven member Board of Governors based in Washington. The primary policy making body in the Federal Reserve is the Federal Open Market Committee (FOMC). The FOMC has twelve members, all seven governors and the presidents of five regional banks (Martin 23-25).

The Fed has three tools it can use to moderate the economy. The most common one is open market operations. Open market operations is just the selling or buying of government securites on the open market. The second tool is the discount rate. The Fed can raise or lower the interest rate it charges other banks for overnight loans. The third and most powerful tool is the reserve requirement. The reserve requirement is the percentage of deposits that a bank is required to have in cash (Grieder 47).

Open market operations affect the economy by increasing or reducing the supply of money. If the Fed wants to increase the supply of money (thereby reducing interest rates) it will buy government securities on the open market. The Fed is then replacing government securities, which are not counted in the primary money supply, with money. To reduce the supply, the Fed does just the opposite, selling government securities (Grieder 48-49).

The discount rate is the amount of interest the Fed charges banks for overnight loans. The Federal Reserve sets a percentage of deposits that all banks must keep in cash, this is called the reserve requirement. If a bank loans out to much money, they have to borrow from the Fed to meet the requirement. If the discount rate is lower than the rates banks can charge on loans, they will loan out more money, increasing the money supply. If the discount rate is higher, banks will loan out less money (Grieder 50).

The reserve requirement is a percentage of deposits that banks are required to hold in cash. If the reserve requirement is high, banks must keep more money in their vaults, instead of loaning it out. If the reserve requirement is low, banks can make more loans and increase the money supply (Grieder 50-51).

The independence of the Federal Reserve is considered crucial to the success of our economy. If Congress or the President had more control over the Federal Reserve they might seek to alter policy for their own gain. For example, a president might choose to relax credit restrictions to spur growth during an election year, regardless of the inflationary consequences. The independence of the Fed prevents this. In 1992, President Bush wanted the Fed to encourage growth, regardless of the consequences. Alan Greenspan and the FOMC refused, knowing it could be harmful to the US Economy. Likewise, if the members of the Board of Governors had to worry about re-election, they might not make the right choices for the long term (Woodward 112-113).

The whole idea of a Federal Reserve is an example of Keynesian Economics. John Maynard Keynes had a significant impact on the post world-war economy. Keynesian Economics also played a role in bringing about an end to the Great Depression. According to Keynes, the government’s duty is to act as employer of last resort during a time of recession. Keynes believed in an extended business cycle, with periods of high employment oscillating with periods of low employment. During times of low employment, the government should spend money, even if it means creating a deficit. A primary problem during a recession is not the lack of money, but the lack of demand. In other words, people have money, but they’re not spending it. According to Keynes, the government can spur demand by spending. Example: During a recession, the government signs a contract to buy 200 fighter planes. The manufacturer of the planes then must hire additional workers. The workers, now that they are employed are going to begin spending more money. This spending will lead other businesses to hire more workers. This is the primary argument against a balanc