Question

You are to write an essay explaining in detail what the role of the Federal Reserve Bank is, including what their key policy tools are and how they are intended to impact the overall economy. Your essay should be approximately 1 page

Answer 1

Federal Reserve Bank is the 'Central Bank' of USA.I would bee focussing more on central bank as it is a more generalised concept.It should be noted that all the functions of a central bank are the functions and role played by the Federal Reserve Bank in the context of US economy.The central bank is an apex body of all the financial institutions in a country.It acts as a banker to the goverment and manages the whole monetary system of the country.It issues currency and is a custodian of foreign exchange reserves.The central bank is not a profit hunting institution.

The main functions of a central bank are as follows:-

• Note issuing agency-The central bank of the country or the Federal bank reserve of US has the monopoly of issuing notes or paper currencies in an economy.Therefore,the federal reserve bank exercises control over the supply of currency in the economy.
• Banker to the Government-The federal reserve bank or the central bank is the banker to the government of that country.All the bank balances of the govt. are kept with the cenral bank and it also receives and makes payments on the behalf of govtb​​​​​​.
• Banker's Bank and Supervisory role-There are usually hundreds of banks in the economy of any country.There should be some agency to regulate,check and balance and supervise the proper functioning of all such commercial banks and other financial institutions related to banking operations.This is done by central bank of any country or more specific by the federal bank in the US economy.
• Lender of Last resort-when commercial banks have exhausted all resources to supplement their funds at times of liquidity crisis,they aapproach central bank as a last resort for help and in such cases the central bank bails out and maintains the solvency and maintains the trust of common public in that bank.
• Controller of credit-This function is the most important function of any central bank or of federal reserve bank in the US economy,the credit plays a decisive role in the growth and expansion of any economy.As per this the central bank controls the availability of credit in the economy and its interest rates.This is done by controlling the supply of money in the economy throgh various ways,means and measures.

Mainly the federal bank performs the controller of credit function using a set of Quantitative and Qualitative tools or measures.It mainly uses two policies rates and two policy ratios under the quantitative measures.They are mentioned below:-

a)Qualitative measures

• Bank rate and Repo rate:These are the rates at which the commercial banks can borrow money from the Federal Reserve Bank to tackle the shortage of liquidity or cash to perform their operations.Using these the federal bank can increase or decrease the supply of money in the economy,this would directly influence the credit creating capabilities of the banks.An increase in such rates discourages to lend credit and vice versa.
• Cash Reserve Ratio(CRR) and Statutory Liquidity Ratio(SLR):-CRR refers to the proportion of the total deposits of the commercial banks which they must keep as cash reserves with the federal bank.These ratios are varied from time to time to control the supply of money in the economy.An increase in this would decrease the supply of credit and vice versa.SLR is the amount of liquid assets of the commercial banks which they must keep with themselves in the form of vault cash as a proportion of their total deposits.

b)Qualitative measures:-

• Margin requirement:This refers to the difference between the current value of the securities offered for loan to the bank and the value of loan granted.This gap is widened to reduce the supply of credit and vice versa.
• Rationing of credit:This refers to the fixation of credit quotas for different business activities.This aims at controlling the flow of credit towards different sectors of the economy.
• Moral suasion:The federal bank regulates the credit supply by the commercial banks during the times of inflation and deflation,through advises,persuasions and pressures.No bank ignores such efforts of the central bank.