Federal Reserve Primary Functions

Federal Reserve Primary Functions and the Effect its Policies Have on
Financial Markets and Institutions
This nation consists of many financial institutions but none are as powerful as the Federal Reserve System and the member banks that own it. The Federal Reserve System’s role as the nation’s central bank ensures that it wields an enormous amount of power and influence on anything to do with money and finances. The Federal Reserve’s policies and actions directly affect the nation’s interest rates, money supply, availability of credit, and inflation rates, all of which impact financial markets and institutions. The following paragraphs will address the Federal Reserve’s primary functions as well as describe the effects its policies have on financial markets and institutions and will include the effect it has on interest rates.
Primary Functions
Several monetary institutions formed in the United States prior to the Federal Reserve but none had the staying power that was necessary and failed, (Timberlake, 2008). The current Federal Reserve was originally established by the Federal Reserve Act in December 1913 and was designed “to furnish an elastic currency”, (Timberlake, 2008), for notes, drafts, and bills of exchange that resulted from actual commercial transactions. The Federal Reserve of today is quite unrecognizable compared to what it started out to be, however its primary functions have not changed. The Federal Reserve was initially put in place to stabilize the country’s banking system, to provide an elastic money supply, improve the banking regulation system as well as the nation’s payment system. The most important function of the Federal Reserve is to establish national monetary policy, open market operations affecting the amount of reserves in the banking system/money supply, and the discount rate at which it lends funds. The Federal Reserve is important in helping to maintain the economical balance of this nation.
Federal Reserve Effects on Financial Markets and Institutions
Monetary policy is the method the Federal Reserve uses to influence the demand, supply, and the price of money and credit which serves to direct the nation’s objectives economically, (Heakal, n.d.). The Federal Reserve uses three tools to accomplish this: open market operations, discount rate, and reserve requirements.
Open market operations are basically the buying and selling of securities issued by the government, such as T-bills issued by the Federal Reserve. The purpose of which is to obtain a preferred amount of reserves held by the Federal Reserve or to alter the price of money through the federal fund rate. Should the Federal Reserve decide to increase the money supply, which decreases the interest rate, it will buy T-bills from the market to make this happen. On the other hand, should there be too much liquidity in the market the Federal Reserve will make the decision to sell T-bills taking money out of the market, signaling that interest rates will increase as well as increasing the demand for money. Too much liquidity in the market can result in increased inflation, (Heakal, n.d.).
The interest rate that banks and other depository institutions are charged to borrow from the Federal Reserve is call the discount rate. Although there are other types of credits available to qualified depository institutions under the federal program such as secondary and seasonal credit, the primary rate is referred to as the discount rate, (Heakal, n.d.). The primary rate is generally used for loans extended overnight to banking and depository facilities to help them to cover the obligations of the day’s transactions if necessary.
Reserve requirements are the amounts of money that a depository institution is required to keep in the vaults of the Federal Reserve. The purpose of storing these funds with the Federal Reserve is that each bank’s liabilities are covered against its customer’s deposits.
Conclusion
In conclusion, the Federal Reserve was initiated to provide an elastic currency and to stabilize the country’s banking system, banking regulation system and the nation’s payment system. The most important function of the Federal Reserve is to establish national monetary policy, open market operations affecting the amount of reserves in the banking system/money supply, and the discount rate at which it lends funds. By using open market operations, discount rate and reserve requirements the Federal Reserve affects almost every financial aspect of our daily lives. Its monetary policy sets the tone of the economic affairs for an entire country by influencing the supply, demand, and cost of money by the actions it performs. References
Timberlake, R.H. (2008). Federal reserve system. Retrieved November 4, 2010 from http://www.econlib.org/library/Enc/FederalReserveSystem.html
Heakal, R. (n.d.). Formulating monetary policy. Retrieved November 5, 2010 from http://222.investopedia.com/articles/04/050504.asp#12892501740691&close

References: Timberlake, R.H. (2008). Federal reserve system. Retrieved November 4, 2010 from http://www.econlib.org/library/Enc/FederalReserveSystem.html Heakal, R. (n.d.). Formulating monetary policy. Retrieved November 5, 2010 from http://222.investopedia.com/articles/04/050504.asp#12892501740691&close