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Federal Reserve System & Banking Regulation

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Assignment Overview

In the individual assignment due this week, students explore the reasons behind regulating banks and how that regulation relates to the formation of the Federal Reserve System. Students demonstrate an understanding of the effects Federal Reserve policies have on interest rates, financial markets, and financial institutions. Students are given the opportunity to participate in additional activities that further explore the risks faced by financial institutions and how those risks are measured.

In the Learning Team assignment due this week, students deepen their understanding of the services provided, main source of funding, interactions with financial markets, and how Federal Reserve policies affect financial institutions.

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Milton Friedman once wrote proposing the primary obstacle keeping the Federal Reserve Bank from meaningful reform was "bureaucratic inertia and the preservation of bureaucratic power and status," (Friedman, 1985). As any of the 13.7 million unemployed American can attest-very little is more important than efficient economic foundation, (BLS, 2011). And as anyone involved in the public sector can attest-very rarely does politics provide sufficient solutions to problems. It's past time to remove politics from the American monetary system. It's time to introduce some science into the foundation of our business.

The Federal Reserve Act of 1913 (amended in 1977) established the Federal Reserve System with the established mandate to promote "maximum employment, stable prices, and moderate long-term interest rates," (12 USC 225a, 1977). The Fed accomplishes this mandate through controlling the monetary base-that is, the supply of dollars available to the market. Three primary tools are used to affect the monetary base, primarily through manipulation of the level of bank reserves, (Mishkin, 2003). These are changing bank reserve currency requirements; discount loans to banks; and open market operations.
First, the Fed defines reserve requirements as the "amount of funds that a depository institution must hold in reserve against specified deposit liabilities," (Federal Reserve System, 2010a). This rate is adjusted rarely, and shows a significant downward trend over the past 50 years. Reserve requirements have been stable around 10% for the past 20 years-displaying the ineffectiveness of changing the reserve requirement in affecting monetary policy in a modern economy.
Next, the Fed controls access to cheap loans available to commercial banks over short periods of time. The rate at which the Fed charges interested for these loans is referred to as the primary credit rate, or more popularly, the discount rate, (Federal Reserve System, 2011). This currently stands at 0.75%. From the 1990's on, the discount rate has been a function of the target Federal Funds rate (Federal Reserve System, 2011).While a useful mechanism to smooth out the operations of the banking industry-as illustrated by the divergent sections of Figure 2, the discount rate is only loosely tied to general interest rates, and therefore is a marginal tool for controlling ...

Solution Summary

6 pages in APA format with references illustrating the history and use of Federal Reserve System for banking regulation in the United States.

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