FEDERAL RESERVE POLICIES TO IMPROVE STATE OF ECONOMY

FEDERAL RESERVE POLICIES TO IMPROVE STATE OF ECONOMY
The Federal Reserve or the Fed is the United States of America’s central bank. This institution is charged with the responsibility of ensuring that the monetary state of the country is in order. Some of its function include the following; it is the lender of last resort for the banks in a country, the financial advisor to the government, discounting checks, the regulator of banks, distributes money in the economy, holding bank deposits and lending money to the government. With such a powerful reign over the economic and monetary institutions of a country, then the FED is by far an invaluable institution. During times of uncertainty in the economy, the FED takes measures to regulate and stabilize the systems to ensure that the economy is in a favorable state to allow for growth.
Some of the economic conditions that may cause uncertainty are, when the prices are rising due to incredible rates of inflation, another indication of economic instability is the consistent decrease in consumer confidence. Consumer confidence is the trust the average income earner has on the existing state of the economy. When the consumer confidence deeps then their spending also decreases. This has a lot of serious ripple effects. For instance, the aggregate demand lowers since the market is not purchasing as much as before. The economic rate of investments also reduces as the stock prices go down. Businesses also suffer a loss of revenue due to decreased sales.

When business revenues plummet then the business, in order to cut costs, has to lay some people of. Such actions by employers lead to a consequent rate increase in natural unemployment.
To regulate the economy the FED can institute some of the following monetary policies. The Open market operation. This is where the FED sells government securities to the public. This measure has the effect of reducing the overall amount of money in the economy since the money received from selling securities is in the hands of the government and it’s stored or invested in various projects. When there is less money in the economy then lending rates increase, consumer demand meets the supply and inflation reduce to a considerable level.
Quantitative easing increases the money supply by flooding the capital markets and by so doing it is creating enough money supply to fund lending. It also leads to the increase in money incomes in the economy. As such people have more disposable incomes to use. Some of the major drawbacks about this policy are that whereas the Central bank can buy securities and other capital assets to increase liquidity and thus the money available to lend, banks may choose not to lend the money. This renders this policy useless since the effect is canceled by the bank’s lack of corporation. The second drawback is the fact that as the money in the economy increases then a state of inflation may arise. Inflation, in this case, will occur because too much money is chasing too few goods. Inflation on its own is a macroeconomic phenomenon that comes riddled with its own consequences and economic challenges. The Federal Reserve is an independent body and while it is formed by the government it tends to keep its own sovereignty. As such if it is given more power to enforce its policies then such measures taken to control the amount of money may not be rendered so volatile and ineffective.
Commercial banks normally lend each other money on an overnight basis so as to maintain the reserve rate. The interest charged on this loan is called the Federal Reserve Rate. The Federal Reserve rate is only applicable to most creditworthy institutions. It is used to control the amount of money available for a particular period of time. If the FED lowers the rate it encourages banks to borrow therefore increasing the money supply, hence lowering of Federal Reserve rate is an expansionary policy. However, if the FED raises the Federal Reserve rate then banks shall be discouraged from borrowing from each other thereby reducing money supply thus this is a contractionary policy.
Commercial banks may have low cash flows leading to low reserves. They thus turn to the Federal Reserve for a loan so as to increase their reserve and cash flow. To ensure that commercial banks can carry on their business the FED offers to commercial banks discounted rate loans. Hence the interest on the loan forwarded to the commercial bank is called the Federal Reserve discount rate. When this rate is low, it gives banks an incentive to source for funding from the FED. This increases the banks’ reserve, cash flow, and money supply. The banks have money to give out as loans and to invest and in doing so generate more and more leading to an increase in cash flow. This lowering of federal discount rate can be termed as expansionary. It increases consumer confidence because it has an effect of making the value of money regain its power. Thus consumers regain their confidence in holding money for transaction purposes. The FED may also discourage borrowing of this loan by increasing the interest on discount loans. An increase in interest on discount loans i.e. discount rate discourages banks from borrowing from the Federal Reserve. This may lead to banks increasing the interests they charge on loans so as to get more cash. The FED may increase the discount rate if there is too much money in circulation. This strategy may be defined as contractionary monetary policy.
Required reserve is the least amount of money that can be held by a commercial bank at any given time. It can also be defined as the total amount of money that banks are required to retain at the central banks. The required reserve ratio shows and determines how much money with each dollar of reserve the banking system can create. The dollar amount and reserve requirement of a bank or a depository institution are established by applying the reserve ratios established by the Federal Reserve Bank to an institution’s or bank’s liabilities. FED may lower or raise the required reserve ratio depending on economic factors. Bringing down the required reserve ratio leads to lowering of required reserve and this will increase the economy’s liquidity as money will be available to give out as loans or investment capital. Thus, reducing this ratio is an expansionary monetary policy. It is mainly done if there is little circulation of money in the market. The FED may also raise the required reserve ratio. This means that banks will need more reserves as the required reserve will also increase. By so doing the money multiplier goes straight down and reduces since cash flow shall reduce. Another effect of reducing this ratio is that it leads to low loan disbursement capabilities of banks and other financial institutions. Due to the lack of capital the investments will also be on a decreasing trend.