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Reserve 1 Federal Federal Reserve Paper Ezzy Ihekoronye FIN/366 April 12, 2011 William Rainwater Federal Reserve 2 Federal Reserve Regulations can be defined as rules, procedure and laws set by government agencies in order to achieve its objectives. In the financial industry, it is set by the Federal Reserve and all banks are required to abide by them as well as keeping them all in unison. This helps regulate the practices of all banking and lending institution. The primary purpose of banking regulations is that it protects individual consumers against banking and lending practices that are deceptive and can potentially harm or violate individual privacy rights. The Federal Reserve which sometimes can be referred to Central Bank is one of the countrys most powerful economic institutions. The Federal Reserve is relevant for Congress not only because the Constitution gives monetary powers to congress but also because congress created the Fed and, therefore, has critically important responsibilities for Federal Reserve oversight. The Federal Reserve and monetary policy is very important in the financial markets because it influences interest rates and stabilizes the financial system. The important of the Federal Reserve cannot be overemphasized. The functions are important because the Federal Reserve is responsible for the management of total spending as well as inflation. The Federal Reserve function also influences foreign exchange rates and other market prices. In times of financial crises, the Fed stabilizes the entire financial system. The Federal Reserve, being the ultimate supplier of system-wide reserves, can satisfy sharp increase in reserve or liquidity demand, thereby stabilizing the financial system. The main functions of the Federal Reserve is that it provides the nations money supply, maintains the safety and soundness of depository institutions, control the growth of money supply, conduct the monetary policy as well as monitor international financial transactions. Decision regarding the cost and availability of credit are another function of the Federal Reserve which helps in promoting high employment, economic growth and price stability in the nation. Federal Reserve 3 The Federal Reserve monitors a wide range of financial variables and responds when these variables seem to indicate that the credit conditions are out of step with its policy. The effect of the Fed policies have on the financial market and institutions are not limited to just depository institutions. The United States has vast financial markets where debt and equity are created and redistributed. These markets are competitive and serve to direct capital to the users with the most urgent demands. Since all financial firms place funds in or borrow from the money market, it helps specialize in instruments with initial maturities of a year or less. The Federal Reserve also uses the market to defer long-term borrowing to a more advantageous time and longer term capital market for investment purposes. The Federal funds rate tends to move to a new level whenever a change is announced. A higher funds interest leads rate to higher market rates and increase incentives for other economic participant to reduce their holdings of money and their use of credit. The effect that this has is that the growth of money balances as the credit slows and at some point, the pace of the real economic activity and of inflation will subside. Conversely, if the Federal funds rate falls, financial institutions will be encouraged to acquire more assets. The adjustment to the interest rate will eventually work to spur monetary growth at the same time increase credit availability and quicken economic activity. It is very important to understand that the Fed does not set the fed funds rate. The fed funds rate is a market-determined rate negotiated between borrowers and lenders in the fed funds market. These fed funds rate are what banks charge to lend overnight funds to one another. The Federal Reserve through open-market operations is able to expand or contract the total reserves which in the short term, has an impact on the interest rate in the economy. There are other factors that affect interest rates on any given day but for the Fed to lower interest rates; it may have to persist in injecting additional reserves into the banking system. Federal Reserve 4 The only interest rate that the Fed can set is the discount rate which is the interest rate that the banks are charged by the Fed if they want to borrow from the Fed. This interest rate is either lowered or raised to signal the Feds intent for the monetary policy. This is one of the most closely watched interest rates in the economy. The effect the Federal Reserve policy has on this type of interest rate is that the rates on the loans are volatile, as it not unusual for the rate to fluctuate more than 25% on either side of the average level in a day. In conclusion, by exercising the three monetary policies; open-market operation, adjustment to the discount rate, and changes to the reserve requirement, the Fed can in the long term run the monetary policy so that people can expect very little change in the price level. By doing so, the interest rates do not fluctuate widely in response to changing inflationary expectations and the value of the dollar is relatively stable over time. The function of Federal Reserve is essential because it sets the nations monetary policy to promote the objectives of maximum employment, stable prices, and moderate long-term interest rates. The Federal Reserve plays an important role in the U.S. economy. They provide banking services to all financial institutions and the federal government. The uniform requirements for all the financial depository institution are set by the Federal Reserve. References Federal Reserve 5 Financial Institution, Market, and Money, 10th Edition Chapter 2: The Federal Reserve and its Powers Author: David S. Kidwell, David W. Blackwell, David A. Whidbee, Richard L. Peterson Financial Institution, Market, and Money, 10th Edition Chapter 3: The Fed and Interest Rates Author: David S. Kidwell, David W. Blackwell, David A. Whidbee, Richard L. Peterson ... View Full Document

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