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The Federal Reserve

Read the following remarks made by news analyst Louis Uchitelle on October 12, 2007 regarding the vital role of the Fed Chairman Benanke in a time of economic crisis such as the financial meltdown started a year ago in the US and the global financial market. The remarks below are followed by the question #1 to answer.

The Federal Reserve, through its power to raise and lower interest rates, exercises more influence over economic growth and the level of employment than any other government entity. That unusual role dates from the 1970s, when the executive branch and Congress pulled back from the use of fiscal tools ? vast New Deal spending and targeted tax cuts ? as a means of regulating prosperity.
President Woodrow Wilson signed the Federal Reserve Act on Dec. 23, 1913, creating a seven-member board of governors, including the Fed chairman, and 12 regional banks ? a structure collectively known as the Federal Reserve System. The governors are appointed by the president and approved by Congress; the regional bank presidents are selected by leaders of their communities, particularly bankers.
Private banks controlled the flow of credit and thus interest rates in the late 19th and early 20th centuries, and farmers, the backbone of the populist movement, complained that the big Eastern banks often starved them of credit at critical moments. Populists called for direct access to credit, without the banks as intermediaries. That did not happen.
The Federal Reserve System was a compromise. The banks would remain the lenders to the public, but the Fed would control the supply of funds on which the banks depended to make loans. Injecting more money into the banking system put downward pressure on interest rates, while its opposite, restricting the supply of potential credit, pushed up rates. The regional banks were intended to help make the flow of credit even across the country.
Through various refinements over the years, this "open market" operation, as it was called, has been at the heart of the Fed's power. The interest rate that results is called the federal funds rate. In turn, the interest that banks and other lenders charge for mortgages and for various forms of commercial and consumer credit fluctuate with the federal funds rate. As a supplement, to assure an even flow of available credit, commercial banks in various parts of the country can borrow directly from the Fed at the nearest regional bank, using the so-called discount window. The discount rate is linked to the federal funds rate.
The federal funds rate is set by the Fed's Open Market Committee, composed of the chairman, currently Ben S. Bernanke, the six other governors, and five of the 12 regional bank presidents, on a rotating basis. The committee meets at Fed headquarters in Washington every six weeks or so.
The Fed's chairman, currently Ben S. Bernanke and before him Alan Greenspan and Paul A. Volcker, dominates Open Market operations. Their main thrust has been to limit inflation, even at the risk of a recession ? although they have cut rates when the nation seemed in danger of one, as the Bernanke Fed has recently done.
? Louis Uchitelle Oct. 12, 20071) The URL link for these remarks is:

In reading the remarks above, and the knowledge you have gathered in this course on monetary and fiscal policy actions, critically describe the transmission process of the Fed's monetary policy action on Oct 29, 2008 of reducing its federal fund rate to 1% - the lowest rate since 1958. Your discussion on the transmission process should focus its impact on credit market crunch, interest rates, investment, consumption in combating the year-long financial meltdown in the Wall Street and its spillover impact on the Main Street. From your learning level of this course, is this policy action a significant departure from the doctrine of deregulation that previously pursued by the former Federal Reserve Chairman Alan Greenspan? Analyze very briefly.

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Solution Summary

The Federal Reserve is assessed.