Macroeconomics

Macroeconomics

Introduction

The Federal Reserve System, commonly known as the Fed, is America's central bank. In recent years, critics of the Fed have argued that the central bank is too quick to raise rates and does so without thinking of the effect its actions will have on consumers nationwide. The bank's seemingly uncompromising stance on inflation may be applauded by some investors, who benefit from low inflation because the value of their holdings does not erode as quickly. However, it can have a negative effect on Americans who may face higher credit-card payments or are no longer able to afford a mortgage to buy a house (Kuttner, 1995, 6-9). Some politicians and policy makers say that the Fed's anti-inflation moves indicate elite insensitivity and a disdain for ordinary Americans. Theorem it is important to determine how the Fed can make the most of the three tools to stimulate economy and contribute to economic development.

Fed's Role in Stimulating Economy

If most people assume that the Fed has done a reasonably good job in steering the economy in recent years, why is there still a large amount of dissatisfaction about the central bank and its role and influence? Most of the complaints center on the Fed's monetary policies, specifically its apparent ability to slow or speed up economic growth depending on its analysis of future economic trends.

The prime rate is important because banks base a variety of other interest rates on it, such as those for small-business loans, credit cards and mortgages. The higher the prime rate, the more consumers have to pay to get credit (Keefe, 2008). As credit becomes more expensive, fewer people try to get it and there is ultimately less money circulating and less economic activity. Also, joblessness usually occurs as interest rates are raised. If the money supply shrinks as a result of higher rates, people have less to spend and goods and services remain unsold. Prices then usually fall. Most manufacturers are then forced to cut back on production, and many businesses lay off workers.

The Three Tools

The Fed controls the key factors influencing the rate of. monetary policy. Monetary instruments by which the central bank may increase or decrease the money supply in the country are:

Operations on the open market (open market operations);

Regulation of interest rates (the discount rate); and

Changes in the level of reserve requirements (reserve requirements).

Open market operations

One of the most often used and flexible tool ...