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The Monetary Behavior as Created by the Federal Reserve - Essay Example
To understand the role of the Federal Reserve, it is necessary, first and foremost, to talk about that which the Federal Reserve exercises power and control over: the United States dollar. It is also important to understand that the dollar is not backed by anything other than the paper on which it is printed…
The Federal Reserve has the power, and has always had the power since its creation, to control the amount of funds in its regional banks throughout the United States. By the Federal Reserve requiring any Federal Reserve banks to keep reserves on hand to handle unexpected outflows as well as meet the demands for the daily operations, it was believed that stability in the behavior and value of a dollar would result (Federal Reserve Bank of San Francisco). These reserves, however, also play an important part in how the Federal Reserve controls the behavior of a US dollar throughout the nation and the world. From day to day, the amount of reserves a bank wants to hold may change in accordance with its daily transactions. Therefore, when a bank finds that it needs additional reserves on a short-term basis, it can borrow them from other banks that happen to have more reserves than they need (Federal Reserve Bank of San Francisco). The interest rate associated with this overnight borrowing of reserves is called the federal funds rate, which adjusts to balance the supply of and demand for reserves. The U.S. Federal Open Market Committee (FOMC) sets a target for the federal funds rate, and keeps the rate on target by increasing and decreasing bank reserves through transactions such as the buying and selling of U.S. Treasuries (Federal Reserve, 2011). This is all done in accordance with the long-term goals of monetary policy as stated above.