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Federal Reserve System

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  • Pages: 5
  • Word count: 1246
  • Category: Banking

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The federal system is the United States central banking system. Its creation took place in the year 1913 with Federal Reserve Act enactment. The federal reserve system contains in it government entity with some private components. In its administration structure, federal system has one board of governor who is appointed by the president, twelve regional Federal Reserve Bank which are located in the major cities of the United States of America. The system has various fiscal policy agents, federal open market committee, several private banks with an obligation of subscribing to a required amount of a stock that is non-transferable in their respective federal reserve bank and several advisory councils (Apel, 2003, p. 55).

The working of the federal system is independent from any intervention from the presidential ratification or decision from any executive member from the government branches. It is only the United States congress mandated to have oversight on the federal system. The Federal Reserve System must ensure that its duties and responsibilities are carried out in relation to the United States financial and economic policies which have been established and formulated by the government. The system is not an organization that is run on private basis and with the aim of making profit.

The regional federal reserve banks’ stock ownership falls under the hands of those banks carrying out their operation within the region and also forms the part of the system. The public purpose and the authority by the Federal Reserve System are derived from the Federal Reserve act that was passed out in the 1913 by the congress. The financial means unto which the Federal Reserve System is operated are offered by the 12 Federal Reserve banks. In providing the sources of the revenue to the Federal Reserve System, each of the reserve bank is organized in a manner that its operations are just like of a private corporation. These funds generated from the each reserve bank are used ton cover the expenditures that arises from the Federal Reserve System operations and the implementation of the board demands (Bach,1990, p. 67).

To understand how Federal Reserve System works in carrying out its duties and responsibilities, it is good to look how it carries out the implementation of monetary policy. The Federal Reserve in this case applies this policy to influence the cost and the availability of credit and money so as to assist in the promotion of the economic national goals. The application of the monetary policy by the Federal Reserve is done by influencing the excess reserves interbank lending. The implementation of United States monetary policy by the Federal Reserve System affects the market balance conditions that the institutions of depository maintains or keeps at the Federal Reserve banks by carrying out what we call open market operation.

The system has been practicing a control that is considerable over the supply of and demand for the federal funds rate and the Federal Reserve balances. Through the federal funds rate control, the Federal Reserve is in position to foster monetary and the financial conditions that are consistence with the objectives of the monetary policy. This has economic influence through its reserves quantity effects that banks adopt to make loans. The action of policy that adds to the system of banking leads to more lending when the rates of interests are very low thus encouraging the credit and money growth, keeping off from excesses that may lead to shortages and inflation that may contribute to economic  growth stagflation. The Federal Reserve makes the application of the monetary policy with the following aims or goals: stabilizing the prices, employment maximization, to ensure long term moderate rate of interests and ensure economic growth that is sustainable (Shull, 2005, p. 102).

The Federal Reserve in implementation of the monetary policy uses the following tools to influence the reserves amount in private banks. Firstly, is the open market operation. This tool deals mostly with the purchases and sales of the united state federal agency securities and the treasury. The open market has been the main principle tool for the Federal Reserve System in the process of implementing the monetary policy. The objectives of the Federal Reserve on open market operation vary as the years goes on. Open market operation in this case entails the buying and selling of the securities of the government, that is the mortgage backed and the federal agency. The term market operation here means that the Federal Reserve decisions on which dealer of securities has to work with in a particular day is not from itself. However, the decision choice comes from the open market, in which the several dealers of securities that the Federal Reserve carries out business with are based on the price competition. The reason as to why the open market operations are commonly used as a monetary tool is because they are more flexible in their application.

The Federal Reserve uses open market operation to regulate the banks reserve supply. This usually deals with the sales and the purchases of the financial instruments, normally the issued securities by the treasury of United States, government sponsored enterprises and the federal agencies. The main aim of trading the securities by the Federal Reserve is to influence the federal funds rate and the bank rates on the borrowings from reserves made between banks. For the purpose of increasing the reserve by the Federal Reserve purchases the securities and also makes deposits to the maintained accounts at the Federal Reserve by the banks it is deals with it. For the purpose of reducing the reserve, what the Federal Reserve does is to sell the securities and collects the accounts. In most cases, the Federal Reserve does not have the interests to either increase or decrease the reserve permanently. However, its main interest or concern is to deal with such issues for a short period of time usually for one or two days. This has an implication that an injection into a reserve today can be withdrawn just tomorrow or some hours later. The second tool that the Federal Reserve System adopts in implementation of monetary policy is the federal funds rate and the discount rate (Shull, 2005, p.123).

The Federal Reserve System in our case targets the discount rates and the federal funds rate in its implementation of the monetary policies. The above rates are charges by the banks themselves for the overnight loans of the funds of federal, which are the held reserves by the banks at the Federal Reserve. The two types of the rate primarily influence the prime rates. The last tool that the federal system applies in its operations for implementing the monetary policy is the reserve requirement. This is also refereed to as required reserve ratio. This tool usually sets the balance that the Federal Reserve System needs the institution of depository to maintain in the Federal Reserve Bank (Broz, 1997, p. 80).


Apel Emmanuel, 2003. Central Banking System Compared: The ECB, the Pre-Euro Boundesbank, and the Federal Reserve System, Routledge, London. Pp. 55

Bach G. 1990. Federal Reserve Policy-Making: A Study in Government Economic Policy Formation, Oxford University Press, Oxford. Pp. 67

Broz J. 1997. The International Origin of the Federal Reserve Sysytem, Praeger, Mahwah, NJ. Pp. 80

Shull Benard, 2005. The Fourth Branch: The federal reserve’s Unlikely Rise to Power and Influence, Praeger, Mahwah, NJ.  Pp. 102, 123

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