Chapter 15, Problem 1AA

To determine

To explain: The role of the Federal Reserve in the economy of the United States.

Explanation of Solution

The Federal Reserve System acts with its network of banks. Fed divides the country into 12 districts of Federal Reserve, each district has a Fed district bank. These district banks are arranged as a corporation whose owner are the member banks. These district banks have further 25 branch banks. Fed is the responsible body for regulating the monetary policy in the United States. The monetary policy includes change in rate of growth of supply of money to maintain the money supply in an economy.

There are many functions which are performed by the Federal Reserve like clearing checks, acting as fiscal agent for the Federal government, supervising the banks, holding the reserves, supply of paper currency, and controlling the money supply. Check clearing is a function by which a check deposited in one institution is transferred to the depository institution of the issuer. Federal reserve maintains the monetary policy by keeping it tight or loose. When Fed implements loose monetary policy, there is abundant credit available in economy, this can also lead further to inflation. On contrary, when Fed implements tight monetary policy, the credit supply becomes short in economy and the economy slows down. In order to maintain the monetary policy, Fed has a banking system which works on fractional reserve banking system. In this system, Fed allows banks to keep only a fraction of deposits in hand as reserve and the remaining amount is available for lending. This is set by Fed in specific reserve requirements for banks.

In situations where a bank has not enough reserves to meet the reserve requirements, the bank can borrow by Fed. In this case, the rate of interest charged by Fed on banks is the discount rate. When banks get money from Fed, they provide this money to businesses in form of loans and the rate of interest they charge from their customers, is the prime rate. To affect or control the money supply in an economy, practice of open-market operations is done by which Fed buys and sells the government securities. This open market is not managed or owned by the government and is open for private businesses also.

Economics Concept Introduction

Introduction:

Federal Reserve-The Federal Reserve was formed in the year 1913 by Congress to act as the central banking organization of nation. It is a system or network of banks. The Federal Reserve or Fed is the body responsible for forming the monetary policies in the United States.