Through an Act of Congress, the US Federal Reserve System was founded on December 23, 1913. Its function is to serve as the central bank of the country and regulate monetary transactions. It is composed of a Board of Governors which has seven members and Reserve Banks numbering to twelve. These Reserve Banks are located in the major cities of the country (Federal Reserve Bank of Atlanta n. pag. ) The Federal Reserve, being the central bank of the United States function to meet the needs of America's complex economy and financial system and to find solutions to the underlying reasons of money panics.
The Federal Reserve Act, which holds the guiding principles of the Federal Reserve, has been amended for numerous times already in order to give the Federal Reserve the power it needs to face the test of times. Unlike other federal systems which are mainly controlled by the government and its officials, the US Federal Reserve is a separate body and functions independently from the government. The federal system does not rely on the appropriations given by Congress but operates using its own earnings.
This process somehow limits the political influences into the system. However, the Congress, having created the system also has the power to alter or abolish it if it desires (Federal Reserve Bank of Atlanta n. pag. ). The primary function of the system is to create monetary policies that will help achieve the overall goals of the fiscal policies of the President and Congress. It also contributes to the safety and soundness of the financial system. The Board of Governors and the Reserve Bank Presidents conglomerate to formulate the monetary policy.
It is the Board's sole responsibility to set the requirements for depositary institutions and approve changes in discount rates proposed by the directors of the Reserve Banks. Through monetary policies, the Federal Reserve is able to contribute to the protection of the U. S. dollar's purchasing power, encourage economic conditions that will help in sustaining financial growth and employment and to foster long term transactions with foreign countries.
Aside from creating monetary policies, the Board also establishes and administers the soundness as well as the safety of the financial system, regulates consumer protection by stabilizing prices, consolidates the banks and balances the flow of money and credit with the economic needs. It also oversees the services provided by Reserve Banks to depositary institutions and approves the budget of the said banks (Federal Reserve Bank of Atlanta n. pag. ).
In order to achieve the balance of the flow of money, credit and economic needs, the Federal Reserve influences the levels of reserves of the financial institutions which in turn will affect the ability of the institutions to purchase investments and make loans (Federal Reserve Bank of Atlanta n. pag. ). The Federal Reserve utilizes three tools in order to influence the reserves these are the open market operations, discount rate and reserve requirements.
The open market operations is the most important and most frequently utilized too due to its flexibility (MSN Encarta online encyclopedia n. pag. ). This tool refers to the sale and purchase in the open market of IOUs or the past issued government securities. The Federal Reserve’s purchase of treasury warrants determines the federal funds rate or the interest rate used by depositary institutions when lending balances to the Federal Reserve which the latter in turn lends to other depositary institutions overnight.
The federal system's purchase of these securities adds credit to the banking system and reduces such credit when it sells the treasury securities to dealers (Federal Reserve Bank of New York n. pag. ). Usually, open market operations are conducted several times a week to prevent technical of temporary forces from negatively affecting the flow of money and credit. As people hold more cash, the bank reserves go down, this phenomenon would in turn cause the short term interest rates to rise.
In order to prevent the surge in interest rates, the Federal Reserve needs to exercise its open market operations tool. The second tool of the Federal Reserve is the discount rate or the rate of interest charged to discount window loans that are only short term. These discount rates are the set by the boards and directors of the reserve banks subject to the Board of Governor's approval.
The changes that may be imposed on the discount rate may either lure or discourage financial institutions from lending or investing because this tool may either make financial activities more or less expensive (Federal Reserve Bank of New York n. pag. ). Among the tools of the federal reserve, this is the tool which the has the least direct effect on the market conditions or the weakest, however, this tool is also essential in the sense that it can make an important signal to the direction of the federal reserve's policies (Texas A&M n. pag. ).
The third tool of the Federal Reserve is the reserve requirement policy. Through this policy, the Federal Reserve has the power to change the deposit percentage which the depository institutions should set aside as reserves (Federal Reserve Bank of New York, n. pag. ). The changes imposed by the Federal Reserve, however, are not changed as often as the discount rate due to the greater impact that it brings to the financial industry. This the least often used tool in making changes in the monetary conditions. Implementation of an increase could cause hardship on banks (Texas am n.
pag. ). Through these tools given to the Federal Reserve, it is able to regulate the economic activites of the country and formulate solutions that will uplift the economy if in case there are problems that is facing. Works Cited “Federal Reserve System. ” n. d. Texas a&m University of Commerce. 9 May 2008 <http://72. 14. 235. 104/search? q=cache:zYqUW8WTGfsJ:faculty. tamu- commerce. edu/dfunderburk/Fin312/notes/Federal%2520Reserve%2520System. htm +least+used+tool+of+the+federal +reserve&hl=tl&ct=clnk&cd=1&gl=ph&client=firefox-a>
“Federal Reserve System. ” 2007. Microsoft Encarta online encyclopedia. 9 May 2008 <http://encarta. msn. com/encyclopedia_761574452_2/Federal_Reserve_System. html> “The Fed's Functions. ” n. d. Federal Reserve of Atlanta. 9 May 2008 <http://www. frbatlanta. org/sf_invoke. cfm? objectid=6DB37523-5056-9F12-12C50DB028186A3E&method=display_body> “Tools of Monetary Policy. ” n. d. Federal Reserve of New York. 9 May 2008 <http://209. 85. 141. 104/search? q=cache:YGNZweA53acJ:www. newyorkfed. org/ education/fed/tools. html+tools+of+monetary