Monetary Policy

Federal Reserve System

The Federal Reserve System was created in 1913 and is the central bank of the United States. "It was created by Congress to provide the nation with a safer, more flexible, and more stable monetary and financial system" (Federal FAQ, 2006). The Federal Reserve has four general areas of responsibilities including, conducting the nation's monetary policy, supervising and regulating banking institutions, maintaining the stability of the financial system, and providing certain services to the U.S. government, to the public, and to financial institutions (Federal Reserve Board, 2005). This paper will give some insight into the Federal Reserve System and its policies.

Federal Reserve Monetary Policy

The term "monetary policy" refers to the actions undertaken by the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals (Federal, 2007). The Federal Reserve influences money and credit conditions in the economy in pursuit of full employment and stable prices. The Federal Reserve uses open market operations, discount rate, and reserve requirements as the three tools to govern the monetary policy.

Open Market Operations - purchases and sales of US Treasury and federal agency securities are the Federal Reserve's principle tool for implementing monetary policy.

The short term objective for open market operations is defined by the federal open market committee. This objective can be a desired quantity of reserves or a desired price. The desired price is the federal funds rate, currently 5.25 basis points (Open Market, 2007).

The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility--the discount window (Discount Rate, 2007). The three types of programs available to depository institutions are primary credit, secondary credit, and seasonal credit. Each program has its own interest rate and is fully secured.

The third tool used by the Federal Reserve System is the reserve requirements. Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Within limits specified by law, the Board of Governors has sole authority over changes in reserve requirements (Reserve Requirements, 2007). Depository institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks. The dollar amount of a depository institution's reserve requirement is determined by applying the reserve ratios specified in the Federal Reserve Board's Regulation D to an institution's reservable liabilities. Reservable liabilities consist of net transaction accounts, nonpersonal time deposits, and Eurocurrency liabilities (Reserve Requirements, 2007).

Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate. When the federal funds rate changes, other rates such as short term interest rates, mortgage rates, and long-term interest rates are subject to change.

Ben Bernanke, Chairman

Ben Bernanke is the current chairman of the Federal Reserve Board. He was born on December 13, 1953 in Augusta, Georgia. Prior to his appointment, Bernanke served for seven months as Chairman of the President's Council of Economic Advisors (Bernanke, 2006).

Dr. Bernanke was a member of the Board of Governors of the Federal Reserve System from 2002 to 2005; a visiting scholar at the Federal Reserve Banks of Philadelphia (1987-89), Boston (1989-90), and New York (1990-91, 1994-96); and a member of the Academic Advisory Panel at the Federal Reserve Bank of New York (1990-2002). Dr. Bernanke's teaching credentials include positions at Princeton, the Graduate School of Business at Stanford University,

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