Question

Write a 2-3 page paper about the Federal Reserve in the United States and Central Banks/Monetary policy around the world. How do these systems work? Why do they exist? How do the influence the global and local economies?

Answer 1

Federal reserve in the USA

Federal reserve system or Fed is the central bank of USA and was created on 23 December, 1913 under the federal reserve act. The need to make a central bank arised in the USA after a series of panics which led to the desire for controlling monetary system in order to alleviate financial crisis. Over so many years the responsibility of the Fed has increased especially after the great depression of the 1930s and great recession during the 2000s. Currently it's chairman is Jerome Powell.

Fed was established by the US congress and there were 3 key objectives which were given to it- maximising employment, price stability and moderating the long term interest rates. It's duties have expanded over the years and now include regulating and supervising commercial banks, maintaining financial stability in the economy, providing financial services to the government of USA, depository institutions and also foreign official institutions. Apart from all these duties, fed also publishes the research it conducts in the beige book and FRED database.

The monetary policy is set by the federal open market committee. There are 7members of board of governors and also 12 regional federal reserve bank presidents who together make the monetary policy for the economy.

Central banks monetary policy around the world

All the nations in the world have there own central banks which provide similar functions like the Fed for their nations. Some of the central banks are People's bank of China, Bank of England, Reserve bank of india, the bank of France and many more.

Central banks around the world issue currency for their respective countries. People have faith in the currency and their is uniformity in note issue. The central banks all around the world use monetary policy for appropriate monetary management in the economy. With the monetary policy the central banks regulate the availability, cost and use of money for achieving its objectives of price stability and management of the economic fluctuations.

Since the late 1980s inflation has emerged as the most important target of the monetary policy all around the world. Many low income countries are also trying to target on the inflation.

Central banks conduct monetary policy by adjusting the money supply in the economy through open market operations. In this the bank buys government securities and bonds to increase the money supply and sells the bonds and securities to decrease the money supply. Low income nations are not very successful with their monetary policy and instead should first develop a framework to target short term interest rates.

After the global crisis, in the advanced countries an easy monetary policy has played a key role in which the central bank reduces the interest rates. Low income countries due to underdevelopment struggle for stability in the policy.

How do they work?

The central bank works by increasing or decreasing the supply of money in the economy. It does this with open market operations, reserve requirement and discount rate.

In the open market operation, the central bank buys and sells government bonds and securities to influence the money supply in the economy. By reserve requirement the commercial banks are required to keep a certain amount of their reserves with the central bank. The central bank can change the rate of these reserves. Discount rate is the rate the central bank charges for lending funds to commercial banks.

Why do they exist?

The existence of central banks is very important to regulate the economy. The government cannot alone look into political and monetary matters. An institution which is particularly made to look after the monetary affairs of the economy is necessary. The central bank has faith of the people as it issues the currency and maintains a balance in the economy. It manages economic fluctuations and also advices the government on the budget. If there was no central bank, the economy would have been a mess for the government to handle.

How do central banks influence global and local economies?

The central banks influence the global and local economies by influencing the interest rates.

If the central bank increase the interest rate, foreigners will be attracted to invest their money in the economy which will increase the inflows of foreign capital. Local residents would prefer investing so as to earn a little extra for the future and cut their present consumption, also less loans will be taken as more interest will have to be paid.

On the other hand if the central bank reduces the interest rate, people will prefer spending more money on present consumption, they will want to invest in countries where interest rate is high so there will be capital outflows. People will take loans as they will not have to pay more interest and more money will be used for productive purposes in the economy. Thus central banks have been focusing on reducing the interest rates.

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