Term Paper on "Federal Reserve System Functions and Issues"

Term Paper 5 pages (1711 words) Sources: 5 Style: APA

[EXCERPT] . . . .

Federal Reserve System

Functions and Issues

The Federal Reserve System has been the main money management and money monitoring system for the U.S. since 1913; it is in fact the "central bank of the United States," according to the Overview of the Federal Reserve System (http://www.federalreserve.gov).There is a wealth of information provided in the Federal Reserve System's Web site - more commonly known as the "Fed" - including a summary of the Fed's duties to the American people. According to the overview, the Fed: a) influences the "monetary and credit conditions" in the U.S. economy while pursuing full employment, "stable prices, and moderate long-term interest rates"; b) regulates all banking institutions to protect consumers; c) oversees the financial markets and attempts to maintain stability of the dollar; d) provides "financial services" to banks, to the U.S. Government and to official institutions overseas.

REVIEW of the FED'S DUTIES

The reason that the Fed was originally established - signed into law by President Woodrow Wilson on Dec. 23, 1913 - was because there had been a number of bank failures in the 19th Century in America, including a "particularly severe crisis in 1907," the Fed's Web site explains. Congress established the National Monetary Commission after that financial crisis and the commission recommended the Federal Reserve Act, which Congress passed and was signed into law. Among the covenants included in the Act was partial independence from political manipulations; that is, the president does not have to sign off on decisions that the Fed makes, albeit the Fed is subject to Congressional oversight, which is reasonable since Congress represents the people / voters of the U.S.

There are twelve regional Federal Reserve Banks and some of those have branch banks; the twelve are located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco. Those dozen regional Reserve Banks actually carry out the responsibility of "distributing the nation's currency and coin," providing supervisory assistance to all banks that are members and also serving as "baker for the U.S. Treasury."

The Fed also has a Board of Governors, which, along with the twelve Reserve Banks, shares responsibility for "supervising and regulating certain financial institutions and activities," the Web site explains. The Federal Open market Committee (FOMC) oversees "open market operations," which is the principle power tool of the Federal Reserve to extend its influence on credit conditions (the FOMC recommends raising or lowering the prime rate of interest used by banks) and overall monetary policies.

The FOMC is made up of the Federal Reserve Board of Governors along with the president of the Federal Reserve Banks of New York and the presidents of four other Federal Reserve Banks (who serve on a rotating basis). Earlier this paper stated that the Fed is independent of direct influence by the executive branch of government, but the executive branch does play a role since the President of the United States appoints the seven members of the Board of Governors - and those appointments are subject to ratification / confirmation by the U.S. Senate.

Meanwhile, the New York Times (http://topics.nytimes.com) asserts that because the Federal Reserve has the power to lower and raise interest rates, it "...exercises more influence over economic growth and the level of employment" than any other federal government agency or entity. The role of being able to raise and lower interest rates dates back to the 1970s, the Times reports, when Congress and the president agreed on a strategy to manage the economy through interest rate manipulation rather than "targeted tax cuts" and "vast New Deal spending" as a way of regulating prosperity.

CURRENT ISSUES the FED MUST DEAL WITH the saga of the declining dollar has turned from a drama into a crisis" (Gerard Baker, editorial writer in the Times in Johannesburg South Africa, November 25, 2007).

A current issue that will involve the Federal Reserve sooner or later - and many economists hope it will be sooner - is the falling value of the dollar against other currencies. An article in the Wall Street Journal (Slater, 2007) points out that "...the dollar now stands at its weakest point in more than a decade." Early in November, 2007, the dollar fell to its lowest ever against the Canadian dollar, and it also reached a 26-year low against the British pound, Slater writes. Even against the Euro, the dollar reached an all-time low (one Euro now buys $1.48 worth of goods compared with $1.00 worth five years ago). It has gotten so bad that "oil-rich nations in the Persian Gulf" - which have almost always "pegged their currencies to the dollar" - are saying in public that they are giving consideration to moving away from the dollar.

What is causing the dollar to continue a free-fall on the international market? Journalist Slater explains that the slide of the dollar is just one part of a "broader worrisome mix" that has as ingredients slow economic growth in the U.S., oil prices that are at a record high (crude oil on November 25 was selling at over $98 per barrel, according to Bloomberg.com), and "mortgage-related turmoil at financial institutions." weakened dollar has a very negative effect for Americans who travel abroad, albeit the consequences thus far have been "largely positive" here in the U.S., the article continues. But the bigger picture is that the weaker the dollar becomes on the overseas markets, the more likely that higher inflations rates will result here in the U.S. And if that happens, international investors may well shy away from buying U.S. government bonds - which America and the Federal Reserve need to continue financing the deficit. Should the foreign investors begin to stay away from purchasing those bonds, the article explains. The Federal Reserve "could be forced to raise U.S. interest rates to attract investment - thereby raising borrowing costs for U.S. consumers and businesses and potentially punishing stock prices."

One can easily see that this economic picture for the U.S. - as the dollar continues to fall - that the Fed will be obliged to play a major role in trying to keep American consumers from being stuck with higher prices. Of course, that was the whole point when Congress and the executive branch got together early in the 20th Century to provide the mechanism for the flow of currency and the strength of the U.S. economy.

If the dollar not only keeps slipping in value, but in fact starts to "tumble in a more rapid, disorderly way," then, according to Russ Koesterich (head of investment strategy for Barclays Global Investors) "...it will impact monetary policy at a time when investors have a very benign view of how the Fed will behave."

The Fed has already reduced its interest rate two times in the months of September and October, 2007.

According to an article in Bloomberg.com (Xie, et al., 2007) there is speculation in the international market that "the dollar is in terminal decline"; and also, says currency analyst Michael Klawitter with Dresdner Kleinwort in Frankfort, Germany, "It's looking increasingly possible that the dollar will lose its status as the major transaction and reserve currency."

Another aspect to the pressure on the Fed to do something about the dollar and the U.S. economy has to do with the housing market. Existing home sales slid to an annual rate of 5 million in October, 2007, which was down from 5.04 in September; that is the lowest rate of home sales since the National Association of Realtors started tallying up that housing data in 1999. "If the housing data turns out to be horrible again," said Boris Schlossberg, the senior currency strategist at DailyFX.com in New York City, "the market will feel assured the Fed must cut rates in December."

Another issue to take into consideration as the dollar plunges downward and the Fed sits nervously by, is that the American economy is slowing down at a time when economies abroad are doing very well, which of course reduces the attractiveness of the dollar in terms of foreign investors. Why invest in American bonds when the Swiss Franc has recently gained against 14 of the 16 major currencies (Xie, 2007), and the Japanese yen has increased to the highest level against the dollar since June of 2005 in the third week of November, 2007?

With that news as a backdrop, additional negative economic news that the Fed surely is aware of is the fact that the organization for Economic Cooperation and Development stated on November 22, Thanksgiving Day, that the "estimated losses from U.S. sub-prime foreclosures may reach as much as $300 billion" (Xie, 2007). On top of that, there have been more than $60 billion that the biggest banks, insurers and brokers have already announced that they will write down in this dreary economic period for housing.

How about the forecast for 2008? The Wall Street Journal article by Joanna Slater reports that the Fed has released new economic forecasts which suggest… READ MORE

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