FREE ESSAY ON THE FEDERAL RESERVE SYSTEM

THE FEDERAL RESERVE SYSTEM

The Federal Reserve System
I would like to start this paper by giving a clear definition of the federal reserve
system: The Federal Reserve System most well known as "the Fed" is the central banking
system and monetary authority of the United States. The Fed is made up of regional
Federal Reserve banks and the Federal Reserve Board of Governors, which their main
responsibility is to supervise and to examine the state-chartered member banks, also to
regulate banks holding companies, and finally to be responsible for the conduct of the
monetary policy. Furthermore, some of the most important duties of the Fed are to keep
full employment and to maintain a low state of inflation (CPI= 2%). 
In order to clearly understand this concept and its purpose, it is also necessary to give
a clear definition of the word money. As stated in the Webster dictionary, money is: "A
commodity, such as gold, or an officially issued coin or paper note that is legally
established as an exchangeable equivalent of all other commodities, such as goods and
services, and is used as a measure of their comparative values on the market." Money has
three basic functions: a medium of exchange, a measure of value, and a store of value.
Goods and services are paid for in money and debts are brought upon and then paid off in
money. Without money, economic transactions would have to take place on a trading basis.
In conclusion, money is a good thing for Humanity. It frees people from spending too much
time running around exchanging goods and services and allows them to undertake other
activities such as pleasure, production, relaxation, contemplation, and temptation.
Back in the early nineteenth century the United States was experiencing a major national
banking crisis. One of the most remembered crises of the United States history was the
Banking Panic of 1907. Abram P. Andrew, secretary of the National Monetary Commission
collected nearly two hundred samples of different bank currencies created to stem the
1907 panic, and he provided a description of the banks' problems at that time. The banks
were so singularly unrelated and independent of each other that the majority of them had
simultaneously engaged in a life and death contest with each other, forgetting for the
time being the solidarity of their mutual interest and their common responsibility to the
community at large.
Two-thirds of the banks of the country entered upon an internecine struggle to obtain
cash, had ceased to extend credit to their customers, had suspended cash payments and
were hoarding such money as they had. What was the result? Thousands of men were thrown
out of work, thousands of firms went into bankruptcy, the trade of the country came to a
standstill, and all this happened simply because the credit system of the country had
ceased to operate. With all of the troubles that the banking system was experiencing,
President Woodrow Wilson passed an act in 1913 that established the Federal Reserve
System (the Fed). Passing that act was the most drastic banking reform in the country's
history.
The Federal Reserve Act of 1913 was made to serve as a lender-of-last-resort in times of
crisis and to provide a national currency that would expand and contract as needed. A
seven member Board of Governors was established to the Fed. They are usually bankers or
economic specialists that are appointed by the President with the advice and consent of
the Senate to 14-year terms. The terms are so long so that the members are protected from
all of the political material that goes on. The President then selects a chairman of the
board who is the chief spokesperson of the Fed. As we all know, the current chairman is
Alan Greenspan. He is the most powerful person in the world concerning monetary policies.
There is a famous saying that "when Alan Greenspan speaks, Wall Street listens." I
personally believe that he is even more important than the president of the United
States. Greenspan is the only person that has enough power to move billions and billions
of dollars with just a simple speech. The Federal Reserve System is also dubbed with the
name The Central Bank of the United States.
Today, the Fed is comprised of twelve regional Federal Reserve Banks spread across the
United States. They are located in New York, St. Louis, San Francisco, Chicago, Atlanta,
Cleveland, Dallas, Philadelphia, Richmond, Minneapolis, and Kansas City. Technically,
each Federal Reserve Bank is privately owned by the member banks in its district, the
very bank it is charged with supervising and regulating. Also, each member bank is
required to buy stock in its district Federal Reserve Bank. This is equal to 6 percent of
its own capital and surplus. Furthermore, of this 6 percent, 3 percent must be paid in
and 3 percent is subject to call by the board of governors. If you look on the left side
of a dollar, you can see which branch it was manufactured at. Each branch acts as a
central bank for private banks in their region. Back in 1980 The Monetary Control Act
resulted that all banks are subject to regulation of the Federal Reserve. Before this
act, banks could choose whether or not they wanted to be "members" of the Fed. After the
act was passed, all banks are required to be a "member".
The Fed has three main policies in which they influence the way banks operate. They are
the legal reserve requirement, the discount rate, and open-market operations. Each policy
powers the reserve and lending capability of banks. The discount rate is not usually a
potent control, but it is important for it may point to the direction that the Federal
Reserve policy goes. The legal reserve ratio is a powerful policy, but changes in it are
rare. Open-market operations have a direct impact on the market and are one of the most
important ways the Fed controls the money supply.
The legal reserve ratio is the ratio of cash reserves to demand deposits that banks are
required to maintain. When the ratio goes up excess reserves get reduced which in turn
reduces the lending possibilities of banks. Banks that loan out all of their excess
reserves are required by the Fed to reduce loans and borrow from the Fed or from other
banks with excess reserves in order to meet a higher reserve requirement. When the legal
reserve ratio goes down, it increases excess reserves, which increases the lending
possibility of banks. 
The discount rate is the rate of interest that the Federal Reserve Bank charges other
banks when banks borrow from them. If the discount rate goes up, it will persuade private
banks to borrow less. That will then lower the private banks excess reserves and force
the banks to raise their interest rates for any loan. The Fed will increase the discount
rate only when they want to slow down the growth in the money supply. On the other hand,
when the Fed reduces the discount rate it will ease the money supply and credit.
Occasionally when the discount changes, it can be viewed as a signal of whether the Fed
is going to pursue a policy of monetary ease or monetary tightness.
Open-market operations are the purchases and sales of government securities by the
Federal Reserve Open Market Committee (FOMC) in order to control the growth in the money
supply. It also puts an influence on bank reserves, loans, and demand deposits. To obtain
an open-market purchase, the Fed buys federal securities from banks or from the non-bank
public. Whoever the Fed buys from, the banks excess reserves are increased. The main
reason the Fed buys federal securities from banks is to increase excess reserves and to
decrease federal securities held by banks. The major influence of an open-market purchase
from non-banks is to increase demand deposits and excess reserves of banks.
The FOMC makes the decision to buy federal securities when they want to expand the money
supply. An open-market sale is just the opposite. Excess reserves and the lending
possibilities of banks are forced down by an open-market sale. Therefore, the FOMC
decides to sell federal securities when they want the money supply to go down.
The act passed in 1913 by President Woodrow Wilson was one of the countries most
essential banking reforms yet. The creation of the Federal Reserve System put the country
bank system in order where it should be. With the new central bank the public can now
trust banks again and help the economy grow to the potential it now has.
Bibliography
Work Cited
Grimes, Paul W. Register, Charles A. Sharp, Ansel M. Economics of Social Issues 15th ed.
McGraw-Hill Co., Inc. 2000. Pages 343-348.
Kaplan, Charles J. Introduction To The Federal Reserve.
http://www.e-analytics.com/bonds/fed1.htm. Equity Analytics, Ltd. 1995.
The Region. Born of a panic: forming the Federal Reserve System.
http://woodrow.mpls.frb.fed.us/pubs/region
/reg888a.html. August 1988.
Ritter Lawrence, Silber William, and Undell Gregory. Principles of Money, Banking, and
Financial Markets. 10 ed. New York: Addison Wesley. 2000. Pg 18-19, 341-347