Federal Reserves Role in the US Economy

The US economy is going through a very bad period; the Subprime crisis has severely affected the US economy. This is arguably the second worse situation that is haunting the US economy. The worst was the great depression which was signaled by the Stock market crash in the year 1930. The Bailout package has been launched by Barrack Obama and it is expected to resolve all the current economic problems. This paper will concentrate on the functions of the Federal Reserve System. A comprehensive understanding of three tools namely, reserve requirements, open market operations, and interest rates will also be provided in this paper.

The central banking system of the United States is informally called as FED and it stands for Federal Reserve System. The US economy faced many banking waves of panic and the primary objective of creating FED was to solve all the banking panics in the country. In addition to this, the FED is also responsible for making taking care of the monetary policy in the US as in taking care of the supply of money in the US.

The Three most Pivotal Tools of FED

The most important job the Fed has is to manage the nations money and the overall economy. Controlling the inflation rate and maintaining employment and production arent easy tasks. The Fed has to have some pretty hefty tools up its sleeve in order to influence the economy of an entire country especially one the size of the United States. (How the FED Works, 10 April 2009).

The banks in the US faced many problems as discussed earlier in the paper; the most important concern was the inability of the banks to pay the depositors and in order to combat the same FED has made it a point to instruct all the banks in the US to set aside some money in the reserve to pay the depositors. This is also called the reserve requirement. The reserve balance that banks must maintain is typically a percentage of their total interest-bearing and non-interest-bearing checking account deposits (currently 3% to 10%). In other words, the amount of a banks required reserves will fluctuate depending on their account totals. The reserve is very important because it helps to ensure that the bank will always be able to give you your money when you ask for it. (The Reserve Requirement, 10 April 2009). If the FED raises the reserve requirement this would mean that the banks would be left with very little money to issue loans to the people and the same will have other major effects on the US economy. This tool is very rarely used by the FED because it can have serious repercussions on the economy of the US. The supply of reserves available in the US is constantly altered by the FED and the same determines whether the interest rates would go up or go down. The process of buying and selling these securities is referred to as open market operations.

The reserve bank is also responsible for issuing loans to other banks and financial institutions, these loans are issued at a particular rate of interest and this rate of interest is better known as the discount rate. The FED does not encourage the banks to borrow but there are occasions when the banks borrow loans but it is only for the short-term emergency needs of the banks. Any change in the discount rate directly affects lending rates and other operations carried out in the open market.

To combat the current economic crisis in the US the FED has cut down the fund rates to 0-0.25% which is the lowest in several years. This will solve many problems; firstly the subprime crisis will immediately be stopped. The people will have to pay much less money to the banks than before. People will not put money in fixed deposits etc, instead, they will put their money in speculative areas to earn more money and the same will stimulate the economy of the US. This is expected to solve the current crisis in the US.