The Federal Reserve Control of the Supply of Money

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 most, however, exposed severe weaknesses in the country's national banking system (Kidwell and Peterson, 1990). 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:

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

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

3. The 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 System was expected to add vigor to bank supervision in the country. Although the System was charged with specific responsibilities with respect to bank supervision, its responsibilities were limited, and the System was not the exclusive federal bank supervision agency.

From the beginning, it was officially recognized that the purposes for which the System

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f monetary control tools, as opposed to alternative control measures. The System engages in open market operations because the securities markets are a convenient and efficient means through which the System may either provide or absorb bank reserves (Auerbach, 1989). Through open market operations, the System may directly influence the demand for bank reserves. Purchases by the System in the open market stimulate bank credit and deposit creation, while sales in the open market restrict bank credit and deposit creation. The System is also able to affect the level of bank reserves for specified shortterm periods, through the use of repurchase agreements. Under such arrangements, the System purchases securities from dealers in the open market. The dealers, in turn, agree to repurchase the securities on a specified date. The maximum term of repurchase agreements is 15days, although in practice they are typically sevendays. Through restricting and contracting available bank reserves through open market operations, the Federal Reserve System is also able to influence interest rate levels. This influence derives from the supply of funds available as a result of the open market operations. With respect to United States Treas
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Approximate Word count = 2621
Approximate Pages = 10 (250 words per page)

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