Money and interest rates Essay

The Federal Reserve System was established in 1913 and it is still the US central bank. Monetary and financial system is provided by the Federal Reserve and its part in the economy has even grown in the last decade.
One of the driving forces creating the need for a central bank in any country is the problem of financial crises and resulting panic.
There are four major areas of the Federal Reserve’s responsibility, such as:
US monetary policy (the Federal Reserve influence the money and credit issues in order to achieve a high level of employment and constant prices;
Banks regulation and control (the Federal Reserve regulates safety of banking and financial system and ensures that the credit rights of consumers are respected);
The stability of the financial system (the Federal Reserve manages financial risks);
Financial services supplying (the Federal Reserve organizes such services for the U.S. government, the public, different financial institutions, etc.) (Broz , 1997)
This paper is dedicated to the analysis of the money and interest rates issues. It’s a review of the certain literature dedicated to important aspects of this element of the Federal Reserve’s policy.
Suppose the Federal Reserve wanted to reduce the money supply. What are some of the tools the Fed would use to achieve this policy objective. (Be sure to use the background materials in your answer).
In general, most important influencing factor of the money supply is the Federal Reserve’s policy. It makes an effect on the money supply by influencing it’s major element – bank deposits.
Regarding the tools that the Federal Reserve use to achieve the reduction of the money supply we can mention a few.
A primary method of reduction of the money supply, an open market operations method, is selling of treasury securities (government bonds).
In this method Federal Reserve actually purchases debt (in the form of Treasury bonds, bills, and the like) issued by its government, and creates money out of thin air to pay for it.
This method is sometimes called contractionary monetary policy. The Federal Reserve sells bonds to investors, banks and various financial institutions and this way it puts the cash out of the circulation. The member of public buys a bond (a paper), where is indicated that he/she becomes an owner of certain amount of money and also a certain percentage of interest. The cash is taken and that is how the amount of cash in circulation is being reduced.
The second option of reduction of the money supply that is often used with the previous primary method is raise of interest rates. If discount rate changes, it means that the federal funds rate becomes lower.
The money supply may be also by reduced by so called a “reserve requirement”, but it’s a rarely used method, especially in a recent times.
The percentage of deposits that banks are required to have at any possible moment that is what the reserve requirement means. If the Federal Reserve raises the reserve requirement on banks, then banks cannot loan out as much cash, and this way it reduces the amount of cash in circulation and reduces the money supply.

The government predicts that economic growth will be slower than expected. What can the Federal Reserve do to increase economic growth? What should it do if it wanted to reduce inflation in terms of the money supply?
According to the article “What goes around. Might central bankers soon start to peer at the monetary dials again”, the economic growth has slowed significantly in the recent years.
In normal times, the Fed expands or contracts its balance sheet through the purchase or sale of Treasury securities. Such actions increase or decrease our asset holdings in the form of government securities and increase or decrease our liabilities in the form of bank reserves. This is the standard mechanism through which the Fed expands money in circulation.
In the last few years of the economic downturn and some financial problems, the the Federal Reserve has taken extraordinary actions in both monetary policy and its lending operations to address the deteriorating economic outlook and the ongoing stresses in financial markets. (Plosser , Jan. 14, 2009).
Certain instability called for unusually low inflation-adjusted, or real, interest rates, which made the Federal Reserve to cut its target very aggressively. Nominal interest rates, however, cannot fall below zero, and this fact can pose a problem for monetary policy. For example, if the economy is weak and nominal interest rates are at or near zero, then a fall in inflation expectations can lead to an increase in real interest rates. This increase would be contrary to what optimal policy would suggest and this is what economists call the zero lower bound problem.
The Federal Reserve uses various programs (and they are not limited only to monetary policy) in order to support the economy revival. These operations include open market operations, the discount rate and reserve requirements.

What major economic indicators would you examine if you were planning to purchase a new car, some business equipment or a house and needed a loan? Explain. How does the Chan article affect decisions by the firm and household?
According to Allen (Leading Economic Indicators Predict Market Trends, from http://www.investopedia.com/articles/economics/08/leading-economic-indicators.asp), there are few economic indicators that may be specifically useful if you making a decision on a big purchase or if you’re going to make loan in order to buy a house.
Major economic are able to give u a general trends of where the economy is heading in the nearest future and what exactly we need to expect from it.
So if you are looking for the indicators that will help you to analyze the situation on housing market, you’ll need to pay your attention particularly to The New Residential Housing Construction Report and The Existing Home Sales Report. These reports are issued on a monthly basis by the Census Bureau and the Department of Housing and Urban Development and by the National Association of Realtors accordingly.
First report, the New Residential Housing Construction Report, will be useful for obtaining building permits information and also will help you to get the knowledge about housing starts and completions.
The Existing Home Sales Report will give you more details on prices, on consumer spending trends and the general information about the housing sector.
If you’re planning to make a purchase the Consumer Confidence Index, the Durable Goods Report and The Business Outlook Survey might be very useful. (Bruce, Feb.28th, 2011)
Chan (2010) indicates that the Federal Reserve is going to raise interest rates starting from 2012, taking into account the current levels of unemployment and inflation.
This raise may have both positive and negative effects. The rate which banks use to borrow money changes, this has a huge effect across the US economy.
Seabury (How Interest Rates Affect The U.S. Markets, from http://www.investopedia.com/articles/stocks/09/how-interest-rates-affect-markets.asp) indicates that the raise of the interest rates means that the households’ income will be less in 2012 due to this factor, and they will have to cut back on spending.
Under this condition fewer loans are made by banks and it influences not only consumers, but companies as well. Firms cut their spending, for example, on new equipment and it cause the lower productivity level.
In regards to the consumers, the decrease in their spending may affect businesses and it also will lead to the growing of unemployment.
The raise of raise interest rates will definitely influence and amend inflation and recession. Summarizing the mentioned above, the raise of interest rates will eventually lead to a significant loss of purchasing power of the consumers.