Monetary Policy and the Federal Reserve System

President Woodrow Wilson signed the Act establishing the Federal Reserve System on December 23, 1913, thus creating a permanent organization performing central bank functions (Dykes, 1989). The Federal Reserve System (commonly referred to as the "Fed"), which consists of a Board of Governors and 12 regional Federal Reserve Banks, serves any number of economic functions. It includes chartered banks in its membership and regulates the daily activities of these banks; it implements and, some would suggest, shapes monetary policy, impacting at both the macroeconomic and microeconomic levels of the market (Solomon, 1990). Managing the money supply in such a way as to stave off economic crises such as a repression or a depression, excessive inflation or stagnation, or currency value fluctuations, are among the chief tasks of the Fed (Solomon, 1990). Given this general background, this report will consider current actions of the Fed as those actions impact on monetary policy, analyzing comments on this issue offered by economist John Kenneth Galbraith in a recent editorial in The New York Times.

In March 2001, John Kenneth Galbraith (2001, p. A15) stated that "the reliance on the Federal Reserve and its cuts in the discount rate proceeds from the wonderful convenience of having an action available that is above politics and much more mentally agreeable than anything of

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Fed is the banker for the U.S. Treasury. However, it must be emphasized that "the most important duties of the Federal Reserve Board and banks are establishing and implementing monetary policy" (Solomon, 1990, p. 290). Expansionary and Contractionary Monetary Policy Dykes (1989) claims that the Fed's independence from government pressure is generally protected by the long, staggered terms of its Board of Governors, though close cooperation with government is essential. This is particularly true with respect to monetary policy, which the Fed approaches with the goal of maintaining a high level of employment as well as stable prices). In economic theory, increasing the money supply is regarded as tending to promote full employment (a major goal of Keynesian economic theory and practice), while contraction of the monetary supply tends to counteract inflation (Solomon, 1990). Difficulties are inevitable in pursuing both goals simultaneously, since it is sometimes hard to forecast the actual effect of investment of a change in monetary policy, given that changes in the velocity of money may undercut the impact of a change in the money supply. Briefly, however, certain types of mechanisms can be employed by the Fed to achieve e
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