The Creation of the Federal Reserve

The Federal Reserve was created by the United States Congress after a series of bank failures that occurred in the times before the Reserves’ creation convinced them of the need to create the agency to ensure the health of the nation’s banking system. (Mankiw, Principles of Economics, 2004, p. 634). Essential Functions

The “Fed”, as the Federal Reserve is simply called, has two different jobs but are equally important jobs; one, being the regulator of the banks in the system, making sure that they comply with the Fed’s regulations and guidelines, and to ensure the health of the banking system. In particular, the Fed monitors each bank’s financial condition and facilitates bank transactions, for example, clearing checks and the like. The second and more important task is to control the amount of money that is made available in the economy, or the Money Supply.

( Mankiw, p. 634). Who runs the Fed? The exercise of the mandate to run the massive operations of maintaining the health and stability of the financial systems of the United States, that is, the power to dispense the authority of the Federal Reserve rest in the hands of its Board of governors, seven individuals who are appointed by the President and whose appointments are then confirmed or rejected by the U. S. Senate, serving 14 year terms that make them independent and insulated from the influences and pressure from both the White House and the Congress.

The Chairman runs the day to day activities of the Reserve and at times is asked to testify at congressional hearing about Fed policies. (Mankiw, p. 634). 2 Control of the Money system Accroding to Gregory Mankiw’s Principles of Economics, The “Fed” does this function by the following instruments at its disposal: 1. By Open Market Operations- Banks lend money to people in relation to the amount of reserves the banks have on deposit with the Federal Reserve. They conduct this when they buy or sell bonds in the market. (Mankiw,2004, p.

639) 2. The Federal Reserve can raise or lower the “discount rate” that it charges the member banks for loans- Generally, this affects the interest rates in the economy. If the rate is lowered, banks borrow more money to lend to customers. (Mankiw, p. 639) 3. The Fed can raise or lower the size of the reserves that member banks must keep in the Federal Reserve against their deposits and thus tighten or expand credit. (Mankiw, p. 639) 4. The Federal Reserve can raise or lower the “margin requirements” for persons buying securities.

The margin requirements define how much money people can borrow to buy stocks. (cited in Immigration Times, 2001) Increasing the money supply When we save our money in a bank, the bank holds that money in deposit for us to be at our disposal when the need arises for it. These monies that are in the safekeeping in the banks but have not been loaned out by the bank are called “reserves”. If the banks do not lend any of their reserves, banks do not influence the supply of money. But the banks can lend out the reserves, if the flow of new deposits and withdrawals are roughly the same.

Thus, banks only need to keep a part of the 3 reserves, thus utilizing a practice called fractional reserve banking, where banks only need to keep a part, or fraction, of their reserves and make the rest available for lending purposes for its clients. (Mankiw, 2004, pp. 639-640) Measuring Inflation Simply put, the primary cause of inflation is the increase of the amount of money. The value of money drops quickly when the Central bank creates or produces large amount of money and pumps it into the system. (Mankiw, p. 669).

To maintain stable prices, the central bank must maintain strict controls over the money supply. To measure inflation, goods that represent of the economy are put together in a “market basket”, the cost of which is compared over time with the cost of the basket at the time the goods were put in the basket. This results in a price index, which again is the cost of the basket as a percentage of the cost of the basket in the starting year. (Barnes, Investopedia, 2007) Natural Disasters: Cause of inflation or deflation?

Natural disasters usually “spike”, or temporarily increase, the prices of several goods and products, but again, only for a short time, as cited in the example. These increases are not by the inadvertent consequence of any policy flaws, but by expectations of people in light of present effects of natural disasters. (Piger, Monetary Trends, 2005). The government counters the effects of deflation, which is the decline in prices, by increasing money supply. Deflation is caused either by decrease in personal or investment spending or government outlays (Investopedia, 2007).

But in the case of natural disasters, the government is more inclined to spend more for reconstruction efforts. 4 Aside for these, there are other costs with regard to inflation. “Shoe leather” costs are the sacrifice of your time and convenience to keep less money on hand than you would if there was no inflation. Menu costs, derived from the restaurant’s cost of printing a new menu, are the costs of price adjustments of products on the market. And inflation makes firms that are being eyed by investors less than what it truly is in terms of suitability for their investments.

They tend to distort the true value of the company in terms of costs that will be needed in the evaluation or subsequent business with the company being eyed. (Mankiw, p. 660) Should Inflation be feared? Conclusion Inflation should not be feared, as inflation can be addressed by policy makers in the government and the needed statutes can be enacted to stave off any negative impact of inflation. Government must take a leading role in the fight against inflation, but the support of the people is also crucial to any program that any agency will take to counter effects of inflation.

The wide spread fear should not be the case, since high inflation is only temporary in nature. All of these just tend to show that things are not in total and unequivocal control of all things, and everything be left to day by day concerns rather than being bogged down in the unseen events in the future, immediate or otherwise. References Barnes, R. Inflation: how is it measured? Retrieved 2007 December 20 from Investopedia database. Investopedia. com http://www. investopedia. com/university/inflation/inflation. asp Immigration Times. com. (2001).

What is the Federal Reserve system? Immigration Times. Volume 4, Issue 4. Retrieved December 20, 2007, from Immigration Times Database. http://www. immigrationtimes. com/exclusive. fed. htm. Mankiw, N. G. (2004). Principles of economics, 3rd ed. 2004 South-Western Pigers, J. Are inflation Expectations Rising from the ashes? Monetary Trends. (November 2005). http://stlouisfed. org/publications/mt/20051101/cover. pdf Olson, T. (2005 October 20). Fed official expects growth. Pittsburgh Tribune review. http://pittsburghlive. com/x/pittsburghtrib/s_385893. html