The US Monetary System, Essay Example

The Purpose and Function of Money

In looking for the purpose of money, one must first think of the price of certain objects; consider the price of a car and how difficult it would be to create a car if there were no money to begin with. If this was the case, people would have to be enslaved, or an exchange for their labor has to be issued, otherwise getting them to cooperate with you would be impossible. There is no efficient way to borrow wealth when currencies do not exist; you would have to gather much resources like food, wood, animals or whatever people would want in exchange for their help in creating your automobile (Laughlin, 1903). You can also get together with other people to be able to pool you resources. However, if things did exist without money, it would be also difficult to trade for them.Money is not only a means of exchange; it has more of a purpose than that. Money can be considered a store value for individuals, for families and even for society. This is seen when money is stored safely away in a bank, you can hold on to your wealth that way and spend it only when necessary needs come in the future.

Money is meant to be able to facilitate trade which is to serve both sides of trade; if this does not work than neither of the parties on either side would want to participate in the trade (Laughlin, 1903). Therefore, the ultimate purpose of money is to make life better. If money is not doing this, then it is being used incorrectly. This can be true for an individual level, and also on the level for a whole society. The function of money requires on to have good faith in its value. The government can be seen destroying that value by printing too much money; this interferes with money’s proper functioning (Laughlin, 1903). Money determines what process is paid for things, this is in contrary to the market deciding how much things are to be worth.

The Federal Reserve Bank

The Unites States’ system of currency production involves three institutions:

1. The Treasury
2. The Federal Reserve Bank, and
3. The traditional banks which are used by individuals (Carmichael, 2009)

The Federal Reserve Bank is the central banking system used in the United States. A need for a central banking system was recognized in the 1910s, and the Federal Reserve Bank was created during the year 1913 by the enactment of the Federal Reserve Act; it is known as a quasi-public – meaning it is both a government entity with private components – banking system which comprises the following:

• The Presidentially appointed Board of Governors of the Federal Reserve System in Washington, D.C.
• The Federal Open Market Committee
• Twelve regional Federal Reserve Banks which are located in major cities
• Numerous private U.S. member banks
• Various advisory councils (Carmichael, 2009)

The Federal Reserve Act states that its purpose is “to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes” (qtd. Carmichael, 2009).

The Federal Reserve Bank handles the nation’s monetary system by fulfilling the following functions: To address the problem of banking panics, to serve as the central bank for the United States, to determine a balance between private interests of banks and the centralized responsibility of government (Carmichael, 2009). This is done through the supervision and regulation of banking systems as well as through protecting the right of consumers. To properly manage the nation’s money supply through monetary policies, some conflicting goals must be achieved. This can be seen as goals of: maximum employment, stable prices – including prevention of either inflation or deflation – and moderate long-term interest rates.

Direction of recent Monetary Policies in the United States

Under operation policies of the Federal reserve, Monetary policies are seen to change. During November 3, 2010 the Federal Open Market Committee (FOMC) was said to decide to expand the Federal Reserve’s holdings of securities in the System Open Market Account (SOMA); this was to promote a stronger pace of economic recovery in regards to inflation (“Federal Reserve Bank”, 2010). Additionally, the FOMC had directed the Desk to continue to reinvest principal payments from agency debt as well as agency mortgage-backed securities into longer-term Treasury securities. According to current estimates, the Desk is seen to expect a reinvestment of $250 billion to $300 billion over the same period; the real amount will be dependent on the evolution of actual principal payments.

Under this estimated distribution, the Desk is said to anticipate that the assets which are to be purchased will have an average duration of between 5 to 6 years (“Federal Reserve Bank”, 2010). This type of distribution can be said to change current market conditions; however the changes will not be designed to alter the average duration of all the assets which are to be purchased.

A provision which offers operational flexibility is needed to ensure that it is able to purchase the most attractive securities on a relative-value basis (“Federal Reserve Bank”, 2010). Purchases are said to be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions which operate through the Desk’s FedTrade system. This is consistent with current practices which are that the result of each operation will be published on the Federal Reserve Bank of New York’s website; this is so that the transparency of each purchase can be determined.

Policy Action of Federal Reserve

The policies of action being taken into the new monetary policy by the Federal Reserve are seen to promote economic recovery and to preserve price stability (“Press Release”, 2010). These observations have two general implications for economic policy in the United States. The economy’s recovery requires the simultaneous implementation of macroeconomic policies to stimulate aggregate demand and of measures; this is believed to help repair banks’ balance sheets and encourage the provision of credit to the economy, the statement made on November 3 coincides with this goal: “the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion” (qtd.“Press Release”, 2010). In this way, a potential vicious circle can be stopped.

Secondly, concerted policy efforts in the economy is needed necessary so that world trade can be revitalized and financial capital flows stabilized in the United States to benefit the national market. This will help support the emerging market economies and global growth, more over the American market. The statement foresees that: “Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth”(qtd. “Press Release”, 2010)

Effects of monetary policies on the economy’s production and employment

The monetary policy affects the United States economy through raising or lowering interest rates; this is to directly affect peoples and firms’ demand for goods and services. The Federal Reserve Bank’s monetary policies directly affect the cost and availability of money; this in turn affects production as well as employment (“Federal Reserve Bank”, 2010). The influence of this on the economy’s labor and production is seen as indirect. For example, when a certain monetary policy is too constricting money supply can be seen as growing too slowly to be able to keep up with business activities; this makes it hard for the business and consumers to obtain credit. The monetary policy is then seen to dampen growth in the economy as well as potentially fording come businesses to lay off their workers. The Federal Reserve Bank’s role is then to implement policies which should ensure that there is money in the economy for continued growth, but not so much that the inflation rate will dramatically rise.

It is suggested that during times of high unemployment rates, the Federal Reserve Bank should be diligent in making sure that money supply is growing fast enough. The new monetary policy was said to be opened due to the observation that household spending did increase slightly, yet levels of unemployment are still at a high. The market is seen to remain “constrained by high unemployment, modest income growth, lower housing wealth, and tight credit” (qtd. “Press Release”, 2010). Therefore the implementation of the said policy is supposed to be able to foster maximum employment as well as price stability.

This strategy is seen to maybe boost economic activity, but only temporarily. In the long-run it is not seen as a cure for high unemployment rates. It has been said that more money in the economy does not always guarantee into greater prosperity. The Federal Reserve Bank has a great indirect impact on America’s labor market (“Federal Reserve Bank”, 2010). The monetary policies cannot directly affect the number of jobs in the economy and their availability, however its impact on things such as economic environment, business activity, and growth (or lack of) in the nation’s money supply will affect the labor market. Both short-term and long-term affects must be considered before the Federal Reserve takes action on policies to ensure the health of the United States economy.

New Monetary Policy Action’s Affect on JP Morgan

To be able to buy Treasury bonds, the Federal Reserve Bank is to hold an auction in which banks can trade with the government as well as the Federal Reserve and submit bids to be able to purchase the bonds. One of the primary dealers seen interested is JP Morgan Chase (Cover, 2010).

For this to work, the primary dealers will sell the bonds to the Federal Reserve Bank, during a time which they think will benefit their firm – this can be from the next day to the near future. The Federal Reserve Bank then will purchase the bonds by crediting banks’ reserves, this can be converted to currency on demand.

Critics have claimed that this could endanger the dollar as well as the economy, and by doing this the value of the dollar will be diluted (Cover, 2010). Additionally, the American people will experience a risk in decreasing the purchasing power of the dollar. However, it is not negative for all sides.

The banks who hold Treasury bonds and who are successful in their bids will be seen to grow in investments and have overall control of monetary funds. If JP Morgan Chase is seen successful in their bids, and if they chose to sell their bonds at “the right time”, this will be a great step forward for the bank, and will definitely affect their power in a positive way as a financial institution (Cover, 2010)

References

Carmichael, G. (2009). The US Monetary System. The Phoenix Economic Examiner. Retrieved from http://www.examiner.com/economic-in-phoenix/the-us-monetary-system-part-2-of-

Cover, M. (2010). Senate Republican Leader has no Opinion “At this point” on Fed Buying $600 Billion in U.S. Debt. CNS News. Retrieved from http://www.cnsnews.com/news/article/senate-minority-leader-has-no-opinion-po

Federal Reserve Bank of New York (2010). Statement Regarding Purchases of Treasury Securities. Retrieved from  http://www.newyorkfed.org/markets/opolicy/operating_policy_101103.html

Laughlin, J.L. (1903). The Principles of Money. Cambridge: University Press.

Press Release (2010). 2010 Monetary Policy Releases. Board of Governors of the Federal Reserve System. Retrieved from http://www.federalreserve.gov/newsevents/press/monetary/20101103a.htm