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WHY DOING BUSINESS WITH THE U.S IS THE RIGHT DECISION

THE INSIDE LOOK OF THE FEDERAL RESERVE

The Federal Reserve System, also known as "The Fed," is the central bank of the United States. In December of 1913, the Fed was created by the congress with the objective of provide the nation with a more flexible, safer, and stable monetary and financial system.

As the bank of the federal government, the Fed also has the responsibilities of being the role model as well as the bank to all the financial institutions within the United States.

The Federal Reserve System includes the Board of Governors and the twelve regional Reserve Banks.Federal Reserve System2

What are the factors that would influence the Federal Reserve in adjusting the discount rate?

Weak EconomyLow Employment LevelsHigh Prices Fluctuation

Low Economy Production CapacityHigh Federal Funds Rates

The discount rate is the interest rate at which an eligible financial institution may borrow funds directly from a Federal Reserve bank.

Some of the factors that influence the fed to adjust the discount rate are: a weak economy, the low employment rates, fluctuation in prices, low economy production of goods and services, and high federal fund rates, which in turn influences inflation and overall interest rates because of the high availability of money. 3How does the discount rate affect the decisions of banks in setting their specific interest rates?

Lower Discount Rates Banks borrow more reservesIncrease in loan offersLower interest rates

Increase Discount RatesBank reserve decreaseFewer loans offersHigher interest rates

Changes in the discount rate are most often used as a signal for monetary policy actions, any type of adjustment to the discount rate affect the bank lending rates. This changes directly affect banking decisions by making it either more or less expensive for banks to get money to lend or hold in reserve, and all open market interest rates in the economy because of its "announcement effect.

Higher or lower rates affect the amount of excess reserves that banks have available to make loans and create money. If the Fed lowers the discount rate, then banks can borrow more reserves, which they can use to make more loans at lower interest rates, which then increases the money supply. If the Fed raises the discount rate, then banks can borrow fewer reserves, which they use to make fewer loans at higher interest rates, which then decreases the money supply. 4

HOW DOES MONETARY POLICY AIM TO AVOID INFLATION?

CONTRACTIONARY MONETARY POLICYSELLING OF U.S. TREASURY SECURITIES-OPEN MARKET OPERATIONSINCREASE IN THE DISCOUNT RATEINCREASE IN RESERVE REQUIREMENTSCONTROL MONEY CREATIONINCREASE IN GOVERNMENT SPENDINGDECREASE IN TAXES5

Influencing inflation takes a long time and has to be looked at as a long-term goal, as a result, the Fed watches economic indicators closely to determine in which the direction the economy is going so it can applies its policies. In the case of forecasting an increase in inflation the, the Fed uses the contractionary monetary policy help to decrease the money supply and raising interest rates. This policy is applied for the purpose of putting the brakes on an overheated business-cycle expansion and to address the problem of inflation.

Monetary policies are the regulation and actions the Fed takes to influence financial conditions in order to achieve its goals, which are but not limited to maximize production and employment and stabilize prices, as specified in a 1977 amendment to the Federal Reserve Act.FED CONTROLLING MONEY SUPPLY

The Fed regulates financial institutions, manages the nation's money and influences the economy. By raising and lowering interest rates, creating money, the Fed can either stimulate or slow down the economy. This manipulation helps maintain low inflation, high employment rates, and manufacturing output. Federal Reserve policy is the most important determinant of the money supply. The Federal Reserve affects the money supply by affecting its most important component, bank deposits. The Federal Reserve requires banks and financial institutions to hold as reserves a fraction of specified deposit liabilities. Depository institutions hold these reserves as cash in their vaults or ATMs and as deposits at Federal Reserve banks. In exchange, the Federal Reserve controls reserves by lending money to depository institutions and changing the Federal Reserve discount rate on these loans and by open-market operations.7HOW DOES MONETARY POLICY CONTROL THE MONEY SUPPLY?

With more money, aggregate expenditures are greaterLow interest ratesInvestmentExpendituresGovernment purchasesNet exports Consumption expendituresThe money supply is the quantity of money that exists in the economy. It is the function of the Federal government to control the total amount of money circulating within the economy; the Fed control the money supply through its monetary policy. The money supply as an aggregate demand determinant causes changes in aggregate demand and shifts of the aggregate demand curve. In the case that the Fed intent to prevent a recession on the business-cycle horizon, the fed decides to expand the money supply. As a result of the extra money circulating in the economy, the purchasing power of all four sectors household, business, government, and foreign improve. 8

With less money, aggregate expenditures are lowerHigh interest ratesInvestment expenditures decreaseGovernment spending stopsNet exports Consumption expenditures Decrease

HOW DOES MONETARY POLICY CONTROL THE MONEY SUPPLY?

In the case that Fed is trying to prevent inflation it might decide to reduce the money supply. As a result of the decrease in money circulating about the economy, the purchasing power of all four sectors household, business, government, and foreign is restricted. Fearing the beginning of higher inflation, the Fed might decide to reduce the money supply by applying its contractionary policy. Everyone is willing and able to buy less real production at the existing price level, which decrease consumption expenditures.9HOW DOES A STIMULUS PROGRAM (THROUGH THE MONEY MULTIPLIER) AFFECT THE MONEY SUPPLY?

Potential Economic Stimulus:Tax cuts for individualsTax cuts for companiesExpenditures on public worksInvestments in research and developmentMost government stimulus are follow by an increase in the money supply to the economy. Some of the different ways of improving the economy are via tax cuts for individual as well for businesses because encourage spending and investments, government spending on public works because it helps by creating contracts for firms and provide employment opportunities, and investment in researches and development to thrive future businesses. This affects the money supply because depending on the goals to achieve the fed increases or tighten the money supply.

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WHAT INDICTORS ARE EVIDENT THAT THERE IS TOO MUCH OR TOO LITTLE MONEY WITHIN THE ECONOMY? HOW IS MONETARY POLICY AIMING TO ADJUST THIS?Too Much Money1. Consumer Spending Increase2. Higher demand for products3. Supply of products decrease4. Prices rise too quicklyLittle Money 1.Decline in purchasing 2. Low Demand for Products 3. Lower PricesStimulus programs are very helpful to the economy because they help to improve an economy suffering from weak aggregate demand as well as help reduce the risk and severity of a recession. However, too much money into the economy could cause inflation. The concept is that if consumers have a lot of extra cash in their pocket they will be more inclined to buy things. If enough people have extra money demand may exceed supply, and prices will rise. If there is too much money in the economy, however, people spend more money and demand increases at a faster rate than supply can match. Prices rise too quickly because of the shortage of products, and inflation results. By forecasting increases in inflation or slow-downs in the economy, the Fed knows whether to increase or decrease the supply of money (Obringer,2002).

11References Obringer, L.A,. (2002)."How the Fed Works. Retrieved from HowStuffWorks.com. 293 January 2012. Schwartz, A.J. "Money Supply." The Concise Encyclopedia of Economics. 2008. Library of Economics and Liberty. Retrieved January 29, 2012 from the World Wide Web: http://www.econlib.org/library/Enc/MoneySupply.html

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