The Federal Reserve, which is a Central Bank, is one of its most powerful institution in economic matters. The US congress in 1913 established the federal reserve. It was mainly designed to give the US more security, elasticity and stability in its economy and financial structure (Hafer, 2005). The federal reserve is charged with the implementation of monetary policies and the overseeing of regulations and management of banking institutions in the US.
Its other duties include protecting the consumer credit rights, maintaining the strength and stability of the financial system and provision of a wide range of services to the citizens, government and other financial institution both in and out of the US. Though its importance is unquestionable, its objectivity and efficiency has been under constant question as there is increased concern on the degree of political influence. History
Before the twentieth century all attempts to have central banks were met with stiff resistance as the majority were of the view that such a move will make America British like, something that did not go well with the majority considering the Britons had colonized the US. When Thomas Woodrow Wilson was elected president, things took a new direction. Under his leadership, the federal reserve and the sixteenth amendment came into place even though they were British like systems.
The federal reserve act also known as The Glass-Owen Bill, popularly referred to as the federal reserve act, was passed on the 23rd of December 1913. The republican controlled senate made it possible to pass the bill unanimously (The Federal Reserve Bank of Richmond, 2008). Within an hour of its passing it was made law was made law after the presidential ascent. Th nature of its inception and the situation surrounding it has always been viewed with suspicion in terms of political motive.
According to the act the federal reserve is an independent central bank though, ironically, the federal government President is charged with the responsibility of appointing its chair (Meltzer &Greenspan, 2008). The act further gave the federal government the power over all monetary policies in US banks. The original law found criticism especially in its Sec. 30 where the right to amend or alter the act is reserved (Meltzer &Greenspan, 2008). Other controversies in the original act were in Sec. 341, where the federal reserve is said to have a succession period of twenty years from its on set unless it is dissolved by the act of congress.
The act has not been amended that much and the only noticeable change is the Sarbanes-Oxley act of 2002 that made it impossible for any public official to be a member of the federal reserve board, a director or an officer. This was a step in trying to bring about accountability and minimize the effect of politics on the outfit as its funding is largely from the congress which is a political outfit (Krautkramer, 2008). The changes in 2002 also brought about some conflict, in that there is a section that state that no member of the congress will be allowed into the inner sanctum of the federal reserve building (Krautkramer, 2008).
This law was seen by many as a means of hiding some kind of information that if brought to the public knowledge would raise questions on the integrity of the federal reserve system (Krautkramer, 2008). The effectiveness of the federal reserve in meeting its objectives was brought into question soon after its signing into law. The New York stock market crash in 1924 cast a doubt on the efficiency of the of federal Reserve system in dealing with crisis (Johnson, 1977).
The reserve system was criticized for not handling the situation well enough, as the stock market crash brought with it unprecedented levels of economic hardship. On the other hand, the federal reserve has received praise in the manner in which it has handled the economic growth in the recent years, especially in reduction of the rate of economic growth to levels that are sustainable by the available infrastructure (Bank of Richmond, 2008). Economic Influence One of the key responsibility of the federal reserve is the regulation of supply of money in order to maintain stability in production, prices and employment.
The reserve therefore has set rules that require banks to keep a minimum amount of money when the demand is low (Hafer, 2005). But when the demand rises the reserve loans some money to the bank to meet the requirement. In this way the federal reserve controls the supply of money and thus manages inflation and stabilizes the value of the dollar. Compared to 1999, the federal reserve has raised the interest rates by a quarter point (Hafer, 2005). The primary motivation being the slowing effect this will have on the growth of the economy and thus prevent uncontrolled inflation.
This increase in interest rates is implemented by the sale of short term securities to financial lending institution notably banks and drawing money from the banks which has a net effect of making borrowing expensive. The reasoning behind this mechanism is that by increasing the cost of borrowing, customer borrowing and spending activities would be reduced and thus the recovery period of the economy would be extended. The most notable effect of raise in interest rates is that banks have increased the rates charged on clients as an a attempt to spread the additional cost of having to pay extra.
This has led to higher loan rates charged by the financial service providers. This negative pressure on consumers is offset by continued expansion of real wages in the short term, this keeps the growth rate at a reasonable level (Krautkramer, 2008). The successful reduction of the interest rates by the federal reserve system, in case of slow economic growth, would revive the economy by encouraging the reduction of prime lending rates by money lending institutions which would translate to lower interest rates for consumers and thus increased borrowing.
Economist recognize that aggregate demand is largely dependent more on monetary policy than on fiscal policy. This implies that the congress passes legislation on taxes in spendings that are intended at affecting the total spending or demand, the effects can be offset by changes in monetary policies implemented by the federal reserve system. An accurate budget deficit, that is counter-cyclical fiscal, is impossible to achieve.
Economist have no common approach to economic effect of changing budget deficits, though they agree that change in monetary policy can have a predictable and potent effect on the overall demand and on the economy in general. The implication is that change in money policy greatly affects the movement of business cycle because of the many booms and recession. Stable monetary policies have an effect of bringing about a stable economic environment.
This has been witnessed in the recent years where the federal reserve instituted policies that were restraining and non-inflatory at have had a stabilizing effect on the US economy (Hafer, 2005). During times of financial crisis the federal reserve acts as a lender of last resort. This implies it has the ability to sort the crisis. The central bank as the ultimate supplier of the system wide reserve can deal with increases in liquidity demands, thereby controlling liquidity shortages and stabilizing the financial system.
Failure in provision of such services, as seen in the 30’s great depression, is disastrous (Greider, 1987). A success is provision of such services is seen in the manner in which liquidity provisions prevented a financial system failure in 1987 and 1989 as a result of stock market crash and decline. The federal reserve and the government are thus charged with the responsibility of ensuring that resources are always availed to the federal reserve to help it in its duties as a last resort lender. Conclusion.
The importance of the federal government in the current fast growing economies, that require evaluation and good control mechanisms, cannot be downplayed. The rate of growth in the overall global economy makes it mandatory for any nation, whose economy has propensity for fast growth, to have a federal reserve system that does the controlling of the overall monetary provisions. The importance is further stressed on by the ever increasing rates of inflation. On the other hand, there is need to have a good look at the act under which the federal reserve system is mandated.
The body should be constituted in such a way that it is truly independent of any political interference and thus restore the faith of the general public in its objectives and operations. This intervention calls for political and moral will in order to implement the changes as the existence of the federal reserve system as a social amenity is something that any economy cannot do without. Work Cited Greider, W. The temple: How US is Run by The Federal Reserve. NY, Simon and Schuster, 1987. Hafer, H. R. The Fed Reserve System: An Encyclopedia. Connecticut,
Greenwood Press, 2005. Johnson, T. R. Historical Beginnings: The Federal Reserve. Boston, Banking and Public Services, 1977 Krautkramer, W. The Federal Reserve : Origin, History and Current Strategy. 2008. 23 Jul. 2008 <http://news. goldseek. com/GoldSeek/1095269452. php> Meltzer, A. H. and Greenspan, A. The Fed. Reserve System Hist: 1913-1951. Chicago, University of Chicago, 2003 Bank of Richmond. The Federal Reserve: Monetary Policy. 2008. 24 Jul. 2008 <http://www. richmondfed. org/publications/educator_resources/federal_reserve_today/advantages. cfm>