Federal Reserve & Monetary Policy

The Federal Reserve & Monetary Policy

Money is a medium of exchange for goods or services. Money is used to measure the value of the commodities within the market. There is a direct relationship between money and price. When the price of a commodity increases, then the value of money decreases. This direct relationship between the prices and the value of money gives a clear understanding of the impact of money on the economy (Mankiw, 2007). By virtue of the nature of money, the primary goal of the US monetary banking system focuses on maximizing production and employment by balancing the relationship between money and price. This accomplishment of this goal is attained through the Central Bank of America, more commonly known as the Federal Reserve Bank.

The Federal Reserve System is responsible for the regulation of the money supply and circulation of currency in the country. The Federal Reserve manages the economy through the monitoring and governing of banks. To perform this tremendous task, the Federal Reserve has organized the Federal Open Market Committee (FOMC). This committee meets regularly to discuss economic concerns and to make changes that are needed. The Committee oversees all things from shortages of money, to regulating the fair banking laws. The committee works with long-term and short-term monetary issues including money shortages, inflation, deflation, and even the current mortgage crisis that the country is experiencing (Federal Reserve Bank, 2010).

An example how this policy system works would be if the committee identifies an economic problem, they will immediately inform the Federal Reserve. The Federal Reserve would then take necessary action. In an example, suppose the committee sees that the housing market is beginning to dip. The committee will then inform the Federal Reserve and the Fed will then lower interest rates in order to boost housing sales. The lowering of interest rates can be an expansive action, since the interest rates on car loans, personal loans, and commercial loans are affected by this action. This policy action referred to as Discount Rate which is just one of the many policy tools used by the Fed to affect monetary change (Federal Reserve Bank, 2010).

The current monetary policy, which is of critical importance, has been the role of the Fed monitoring the banking system with increasing supervision. Here the FOMC outlines their concerns for the Fed, “All individual financial institutions that are so large and interconnected that their failure could threaten the functioning of the financial system must be subject to strong consolidated supervision (Image of Seal of the Board, 2010).”

The committee is referring to the fall of Bears Stearns, Fannie Mae, and Freddie Mack and even AIG. The fear is that a similar catastrophic event could happen again without banking supervision. The real question that was posed by the current problems has been with regard to the ‘ability’ of the Fed to effectively manage these massive banking and mortgage institutions. With regard to this, the committee answers, “As a result of its central banking responsibilities, the Federal Reserve possesses expertise in those areas that is unmatched in government and that would be difficult and costly for another agency to replicate (Image of Seal of the Board, 2010).”

The economic ramifications of increased Fed supervision are arguably beneficial and negative. By monitoring the banking industries in greater detail (with regard to mortgages and loans) the Fed will be safeguarding taxpayers by making sure that lenders follow specific guidelines and lending practices. The use of substandard lending will fade and thus the risk of financial collapse.

However, the process of lending will significantly increase in time consumption because of the government involvement. Loans will become increasingly more difficult to get because of the complexity of guidelines that must be followed. As well, the qualifications for loans will be made more difficult.

One can see how the Fed’s monetary policies are far reaching and affect many segments of the economy. In this instance, if the Fed assumes greater control of the lending industry, the long-term effects on the country will be seen not just in the lending industry but also in the building and construction industry. If homes become harder to buy, the demand for them will decrease and builders will decrease production of them. This will mean loss of jobs in the construction fields and in the lending industry. But this change might be necessary for the Fed to ensure a stable housing and lending market.

References

Federal Reserve Bank, . (2010, July). Monetary policy. Retrieved from http://www.federalreserve.gov/monetarypolicy/default.htm

Heshmeyer, M. (2009). Real World Economics, Dollars & Sense. Retrieved on April 20, 2010 from http://www.dollarsandsense.org/blog

Image of Seal of the Board, . (2010, January 13). The Public policy case for a role for the federal reserve in bank supervision and regulation. Retrieved from http://www.federalreserve.gov/BoardDocs/RptCongress/supervision/supervision_ report.pdf

Mankiw, N. (2007). Principles of Economics (4th ed.). Mason, OH: Thomson South-Western

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