FREE ESSAY ON THE FEDERAL RESERVE

THE FEDERAL RESERVE

When you look up the word money in the dictionary, you get this as the definition: "A
commodity, such as gold, or an officially issued coin or paper note that is legally
established as an exchangeable equivalent of all other commodities, such as goods and
services, and is used as a measure of their comparative values on the market." Money has
three basic functions: a medium of exchange, a measure of value, and a store of value.
Goods and services are paid for in money and debts are brought upon and then paid off in
money. Without money, economic transactions would have to take place on a trading basis.
But who controls all of our countries money? 
Back in the early nineteenth century our country was experiencing major national banking
panics. One of the most remembered of these panics was the Banking Panic of 1907. Abram
P. Andrew, secretary of the National Monetary Commission collected nearly two hundred
samples of different bank currencies created to stem the 1907 panic, and he provided a
description of the banks' problems at that time: 
[The banks] were so singularly unrelated and independent of each other that the majority
of them had simultaneously engaged in a life and death contest with each other,
forgetting for the time being the solidarity of their mutual interest and their common
responsibility to the community at large. Two-thirds of the banks of the country entered
upon an internecine struggle to obtain cash, had ceased to extend credit to their
customers, had suspended cash payments and were hoarding such money as they had. What was
the result? ... Thousands of men were thrown out of work, thousands of firms went into
bankruptcy, the trade of the country came to a standstill, and all this happened simply
because the credit system of the country had ceased to operate. (The Region, 1988)
With all of the troubles the banking system was experiencing, President Woodrow Wilson
passed an act in 1913 that established the Federal Reserve System (the Fed). Passing that
act was the most drastic banking reform in the country's history. The Federal Reserve Act
of 1913 was made to serve as a lender-of-last-resort in times of crisis and to provide a
national currency that would expand and contract as needed. A seven member Board of
Governors runs the Fed. They are usually bankers or economic specialists that are
appointed by the President to 14-year terms. The terms are so long so that the members
are protected from all of the political material that goes on. The President then selects
a chairman of the board who is the chief spokesperson of the Fed. The current chairman is
Alan Greenspan. 
The Federal Reserve System is also dubbed with the name The Central Bank of the United
States. Today the Fed is comprised of twelve regional Federal Reserve Banks spread across
the United States. They are located in New York, St. Louis, San Francisco, Chicago,
Atlanta, Cleveland, Dallas, Philadelphia, Richmond, Minneapolis, and Kansas City. If you
look on the left side of a dollar, you can see which branch it was manufactured at. Each
branch acts as a central bank for private banks in their region. Back in 1980 The
Monetary Control Act resulted that all banks are subject to regulation of the Federal
Reserve. Before this act, banks could choose whether or not they wanted to be "members"
of the Fed. After the act was passed, all banks are required to be a "member". 
The Fed has three main policies in which they influence the way banks operate. They are
the legal reserve requirement, the discount rate, and open-market operations. Each policy
powers the reserve and lending capability of banks. The discount rate is not usually a
potent control, but it is important for it may point to the direction that the Federal
Reserve policy goes. The legal reserve ratio is a powerful policy, but changes in it are
rare. Open-market operations have a direct impact on the market and are one of the most
important ways the Fed controls the money supply.
The legal reserve ratio is the ratio of cash reserves to demand deposits that banks are
required to maintain. When the ratio goes up excess reserves get reduced which in turn
reduces the lending possibilities of banks. Banks that loan out all of their excess
reserves are required by the Fed to reduce loans and borrow from the Fed or from other
banks with excess reserves in order to meet a higher reserve requirement. When the legal
reserve ratio goes down, it increases excess reserves, which increases the lending
possibility of banks. 
The discount rate is the rate of interest that the Federal Reserve Bank charged other
banks when banks borrow from them. If the discount rate goes up, it will persuade private
banks to borrow less. That will then lower the private banks excess reserves and force
the banks to raise their interest rates for any loan. The Fed will increase the discount
rate only when they want to slow down the growth in the money supply. On the other hand,
when the Fed reduces the discount rate it will ease the money supply and credit.
Occasionally when the discount changes, it can be viewed as a signal of whether the Fed
is going to pursue a policy of monetary ease or monetary tightness.
Open-market operations are the purchases and sales of government securities by the
Federal Reserve Open Market Committee (FOMC) in order to control the growth in the money
supply. It also puts an influence on bank reserves, loans, and demand deposits. To obtain
an open-market purchase, the Fed buys federal securities from banks or from the nonbank
public. Whoever the Fed buys from, the banks excess reserves are increased. The main
reason the Fed buys federal securities from banks is to increase excess reserves and to
decrease federal securities held by banks. The major influence of an open-market purchase
from nonbanks is to increase demand deposits and excess reserves of banks. The FOMC makes
the decision to buy federal securities when they want to expand the money supply. An
open-market sale is just the opposite. Excess reserves and the lending possibilities of
banks are forced down by an open-market sale. Therefore, the FOMC decides to sell federal
securities when they want the money supply to go down. 
The act passed in 1913 by President Woodrow Wilson was one of the countries most
essential banking reforms yet. The creation of the Federal Reserve put the country bank
into order where it should be. With the new central bank the public can now trust banks
again and help the economy grow to the potential it has.
Bibliography
Kaplan, Charles J. Introduction To The Federal Reserve. 
http://www.e-analytics.com/bonds/fed1.htm. Equity Analytics, Ltd. 1995
The Region. Born of a panic: forming the Federal Reserve System.
http://woodrow.mpls.frb.fed.us/pubs/region/reg888a.html. August 1988
Grimes, Paul W. Register, Charles A. Sharp, Ansel M. Economics of Social Issues 15th ed.
McGraw-Hill Co., Inc. 2000. Pages 343-348.