The Federal Reserve and how it controls money in the economy.
“The Federal Reserve System, also known as "The Fed," is the central bank of the United States. In its role as a central bank, the Fed is a bank for other banks and a bank for the federal government. It was created to provide the nation with a safer, more flexible, and more stable monetary and financial system. Over the years, its role in banking and the economy has expanded. The Federal Reserve System is a network of twelve Federal Reserve Banks and a number of branches under the general oversight of the Board of Governors. The Reserve Banks are the operating arms of the central bank.” (Federal Reserve kids, 2010)
Now that I have explained what the Federal Reserve System is I will discuss how the Feds respond when there is too much money or a shortage of money in the economy. Although, the Feds most important responsibility is to ensure that there is enough money and credit in circulation to stimulate growth in the economy, a surplus of money in the economy can result in the decline of the value of our currency. Too much money in the economy results in inflation which means that the prices of goods and services are rising but our currency has limited purchasing power. When there is a shortage of money in the economy the result is deflation, this is a general decline in prices, it is often caused by a reduction in the supply of money or credit. When there is a shortage of money in the economy the value of our currency will rise.
The Feds uses three tools to slow down or increase the growth of the money supply. The monetary policy tools used are the discount rate, reserve requirements and open market operations. The discount rate is “the interest rates the Feds charge banks that borrow from the reserves.” (McEachern, 2011)
When the Feds are trying to slow down the growth of money they may increase the discount rate. An increase in the discount rate will discourage the banks from borrowing...