Federal Reserve Interest Rate Policies

A severe financial crisis occurred in the United States in 1907. Unfortunately, the crisis was just the latest in a long line of such crises. The crisis of 1907, more than was true of most of these crises, however, exposed severe weaknesses in the country's national banking system (Kidwell and Peterson, 1992, p. 112). The creation of the Federal Reserve System through the Federal Reserve Act of 1913 was intended to correct those deficiencies. The Act had four stated goals, as follows (Kidwell and Peterson, 1992, p. 112):

1. The Federal Reserve System was to act as the central monetary authority for the country. In this capacity, the agency was expected to expand and contract the country's money supply according to the needs of the economy.

2. The agency was to act as a lender of last resort. In this role, the Federal Reserve System was expected to furnish additional funds to member banks during periods of financial crisis.

3. The Federal Reserve System was to establish and operate an efficient system for the clearing and collecting of checks. This payment system was to be operational nationwide.

4. The agency was expected to add vigor to bank super-vision in the country. Although the Fed

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Federal Reserve Banks is the second monetary tool. Through this activity, the Federal Reserve System sets the interest rate that must be charged when member banks borrow from the Federal Reserve Bank in their region. Although this activity does not establish directly the level of interest rates through-out the American economy, it is the major factor considered by financial institutions in the establishment of interest rates. The level of interest rates in the economy has an impact on the demand for credit funds. 3. Changing member bank reserve requirements is the third monetary tool. The reserve requirement for a member bank prescribes what proportion of its deposits must be retained. The remaining amount may be legally loaned to borrowers at interest. The reserve requirements are a means of regulating the money supply. A reduction in the reserve requirements has the effect of loosening, or increasing, the money supply, while an increase in the reserve requirements has the effect of tightening, or decreasing, the money supply. Changes in the money supply affect interest rates. In addition to the three primary monetary control tools described above, the Federal Reserve System also has available three additional tools. These add
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Approximate Pages = 16 (250 words per page)

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