The Federal Reserve System also known as the Federal Reserve was formed on December 23rd 1913 after the approval of Federal Reserve act (Beckhart, 2). The enactment of the act was accelerated by a series of financial panics, mainly by a severe panic in 1907(Bechart,2).It’s main objective was; to provide economic stability by formulating and implementing monetary policies that will ensure price stability, to facilitate discounting of commercial papers and lastly to regulate the activities of commercial banks (Prochnow,3).
However the goal of the Federal Reserve has changed overtime and broadened to accommodate other economic changes that have occurred. Events such as Great depressions and the recent financial crisis are some of the factors that have led to expansion of Federal Reserve duties and responsibilities.
STRUCTURE OF THE FEDERAL RESERVE
The system has its own unique structure which incorporates both public and private, and is managed independently without any interference or direction from the federal government (Prochnow, 6). It is guided by the Federal Reserve act which outlines its duties and responsibilities in running of its affairs. Its four main components are; the board of governors, the federal open market committee, the twelve regional reserve banks and the member banks throughout the country (Beckhart, 8).
The board of governors consist of seven members who are appointed by the president with the approval of the senate, their main task include formulating and implementing of monetary policies and regulation of the 12 district reserve banks(Beckhart,23). The governors serve for staggered fourteen years to ensure continuity and stability (Beckhart, 23). The chairman and vice chairman of the board are appointed by the president from the seven members for a four year term but they can be re-nominated until their term expires. The board is also required by the law to submit its report to the speaker of the house of the representatives annually; they can be called by congress to testify and are required to maintain good working relation with other government departments (prochnow, 9).
The 12 Federal Reserve banks also make up the federals reserve system. Each of the 12 reserve banks serves in its region and has offices in its district’s so as render services to the depository institutions and the public in general (Prochnow, 7). The reserve banks are often referred to as “bankers’ bank” because it is charged with storing coins and notes and processing electronic payments and checks (Beckhert, 13). They also undertake research on regional, national and international economic issues. Reserve banks also regulates commercial banks in their regions and handles treasury’s payments and sell of government securities. In general Federal Reserve banks bring important regional perspective for the Federal Reserve System to undertake its duties effectively (Prochnow, 9).
Federal open market operation committee main duty is formulation of monetary policies so as ensure price stability and full employment (Prochnow, 3). The members of the committee are the board of governors and the president of the reserve banks. The chairman of the board of governors is the one who chairs the federal open market operation committee (Prochnow, 11).
It is approximated that 38% of the commercial banks in United Nations are members of the Federal Reserve System (Prochnow, 7). The member banks are stakeholders in their districts and therefore they are required to hold 3% of their stock in federal banks (Prochnow, 7). These banks are very important in implementation of the monetary policies that are used in control of credits.
PURPOSE OF THE FEDERAL RESERVE SYSTEM
The primary purpose of the Federal Reserve was to deal with banking panics and other functions that is stipulated in the Federal Reserve act such as; furnish currency elasticity, supervise commercial banks and to provide an affordable means of rediscounting commercial papers (Berkhert, 24). However with time the functions of the Federal Reserve System has broadened and today the functions of the Federal Reserve System are the following;
- Conducting monetary policies
The Federal Reserve System is currently tasked with the job of formulating and implementing the monetary policies. The federal open market operation committee meets regularly to assess the state of national economy and discuss the necessary measures that should be put in place to ensure price stability and economic growth. The committee can recommend measures such as increasing the discount rate or increasing the bank reserves if they want to curb high price level in the economy. Simply the main aim of monetary policy is to control the amount of money supply in the economy which in turn will lead to price stability (Beckhert, 6).
- Supervise and regulate commercial bank
The Federal Reserve also supervises and regulates commercial banks in united state so as to protect the interest of consumers and also to ensure that the monetary policies are implemented fully by the banks (Prochnow, 12).
The federal bank regulates the activities of the commercial banks by; storing currencies, making loans to them and also processing checks and other electronic payments. The Federal Reserve advance loans to the banks at a discount rate which is then used by the commercial banks to set their interest rate, therefore by increasing and decreasing the discount rate the Federal Reserve is able to control the activities of the central bank.
- Maintaining the stability of financial system
Federal Reserve System was mainly created to deal with banking panics in the economy; inoder to achieve this goal therefore the Federal Reserve must maintain the stability of the financial system. The Federal Reserve is the lender of last resort to the banking institutions; whenever the bank has run out of cash to pay its demand deposit the central bank intervenes by giving them loans, so as curb any tension from the depositors.
The Federal Reserve also requires the commercial banks to keep some proportion of the demand deposit so that the bank will not run out of liquid cash whenever the depositors want to withdraw their money.
The Federal Reserve also gives special loans to ailing financial institution so as restore both investors and customers’ confidence.
- Central bank of united state
Federal Reserve also act as the government bank, they store large amount of money for the government and also process payment on behalf of the government. The Federal Reserve also sells and buys securities on behalf of the government so as to raise money in case of the budget deficit.
They are also charged with printing of currencies in the nation. They issue both coins and notes in to the nation (Prochnow, 25).
MONETARY POLICIES USED BY FEDERAL RESERVE
Monetary policies refer to any actions taken by the Federal Reserve so as to influence the amount of money supply in the economy. In order to achieve its objective of ensuring full employment and price stability the Federal Reserve uses the following policies;
OPEN MARKET OPERATION
Open market operation is a tool used by the Federal Reserve to control the supply of money by selling and buying government securities. If the Federal Reserve found out that there is excess money supply in the economy, they will sell government securities to the people so as to get rid of the excess liquid money in the economy. And if there is shortage of money supply the Federal Reserve will buy the bonds from the public so as to release so as to release liquid cash to the economy and boost money supply (Beckhert, 34).
Discount rate is the rate at which the Federal Reserve advances credit to the commercial banks. Commercial bank then uses it as a basis of setting its own interest rate which is always higher than the discount rate. The Federal Reserve will therefore increase the discount rate if they want to reduce the money supply in the economy, this will lead to a reduction on credit because the cost of credit is high and people will be discouraged to borrow thus reducing money supply.
If the money supply is low in the economy, the Federal Reserve will reduce the lending rate which in turn increases the level of borrowing in the economy and therefore increases the money supply in the economy.
Another instrument that can be used by the Federal Reserve to control money supply is required reserve ratio. This is the proportion of liquid money that the commercial banks are supposed to keep against the demand deposit. The Federal Reserve may increase or decrease the Federal Reserve ratio depending on the state of economy.
If the economy is experiencing high inflation rate, the Federal Reserve may increases the required reserve ratio so that to limit the amount funds that is available for borrowing by the public, this will reduce the money supply in the economy which in turn will reduce the demand of goods and services thus the price will fall.
The Federal Reserve System: Purposes & Functions. New York: Books for Business, 2002. Print.
Prochnow, Herbert V. The Federal Reserve System. New York: Harper, 1960. Print.
Beckhart, Benjamin H. Federal Reserve System. New York: American Institute of Banking, 1972. Print.