Federal Reserve was created by the Federal Reserve Act of 1913 for the provision of leaders that will guide the monetary system on the country as well as implementing policies in the economy to ensure the stability of the monetary system. As compared to banks, Federal Reserve is not a profit oriented one rather for the welfare of the economy as a whole. Basically, the major decision maker of the Federal Reserve are the Boar of Governors which are being appointed by the President and Confirmed by the Senate which will serve for a term of 14 years in office.
It is also the President who select and the Senate is the one that confirms the selected persons from the Board that would fill the position of Chairman and Vice Chairman for a four years term. The Federal Reserve controls the monetary system by increasing or cutting down the money supply available in the economy. In addition, Federal Reserve monitors and intervene depending of their current policies to the foreign exchange market to safeguard the condition of the currency which is very vital for the performance of the entire economy especially those import and export industries.
They also buy and sell government securities to influence the economy to put its condition back to equilibrium condition. Federal Reserve could increase the money supply buy printing more money for the economy, but only on an adequate level to avoid inflation and other negative effects of having more money on the hands of the consumers. Another way, by which Federal Reserve could increase money supply, is through buying of the government securities from the public. In this case, the Federal Reserve now made the public to hold money instead of government securities.
Implementing policies to the banks such as cutting of the vault reserves of the banks for them to be able to have more capital to invest which in turn increase the money supply in the economy by infusing more investment funds to the market. Inflation is being measured through comparing the prices of the commodities in the market year after years to guide policy makers about the current condition of various industries and the driving factors for the occurrence of this event.
The formula for computing inflation is: Inflation = ([P0 – P1] / P1) x 100 One of the possible causes of inflation, as I have mentioned a while ago is the printing of more money for supply the economy since more people would buy more good since they have more money on their hands and this would make the industries to increase their prices to take advantage of the higher spending of the consumers until such point wherein the rate of increase in the prices harms the entire economy.
Expectation for inflation rate is also, in some other way, harmful for the economy for the producers would consider it in setting their prices even if higher inflation rate is less likely to occur (Piger, 2005). Inflation could also be triggered by natural calamities such as hurricanes and tornadoes. These natural calamities impose severe damages to the industries especially to the agriculture industry. With this, prices of the agricultural products to the market increases abruptly for the producers to pass the burden of possible losses to the consumers.
Increase in the price of oil in the world market would also make the price of the commodities in the economy to increase since oil is one of the primary inputs of producers in transporting their goods from one place to another (Olson, 2005). If the prices of oils increases, operational costs of producers would also increase and for them not to be negatively affected by the increase in their operational costs they will increase the prices of their goods to pass the burden to the consumers. Natural disasters causes inflation since, as I have said a while ago, it causes damages to various industries especially the agriculture sector.
Shortages are more likely to occur during natural calamities or disasters and this would give the producers to take the opportunity of increasing their prices to at least make break even with the losses that they incur from a certain calamity. One of the famous costs of inflation would be the shoe leather costs. This happens when people have a hard time searching for cheap good during the existence of inflation in the economy until such time that their shoe leather wore out. Another cost of inflation would be the menu costs (Sinclair, 2003).
It is the costs acquired by the firm from frequently changing the prices of their meal being offered to adjust to the current level of inflation. In addition, unexpected inflation would make bank savers to lose some of their money since their money could now buy less number of goods if the interest rate in the back is not sufficient enough to cover the abrupt increase in the prices in the market. The reason why inflation is widely feared is from the fact that it imposes losses to bank savers as well as to the consumer group.
Having high inflation rate would discourage foreign direct investment due to the costly operational maintenance. More businesses are shutting down because they could no longer withstand the inflation effects and this causes a major problem to the tax revenue of the government. Consumers could now buy less number of goods as compared before and there is a possibility that they would cut their consumption to save money for now and consume it by the time deflation occurs.
REFERENCES Sinclair, P. (2003) Can Menu Costs Justify Inflation? Retrieved October 12, 2007, from http://repec. org/mmfc03/Sinclair. pdf Olson, T. (2005) Fed Official Expect Growth. Retrieved October 12, 2007, from http://www. pittsburghlive. com/x/pittsburghtrib/s_385893. html Piger, J. M. (2005) Are Inflation Expectation Rising from Ashes? Retrieved October 12, 2007, from http://research. stlouisfed. org/publications/mt/20051101/cover. pdf