The Political Economy of the Federal Reserve Essay Sample
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INTRODUCTION: The term political economy can be used to refer to different scenarios in different fields of study. Generally, it is commonly used to refer to the interdisciplinary studies that involve economics, law and political science. As such, it is used to explain how political institutions, capitalism and the political environment relate to each other and more specifically, it is used to analyze issues of public policy concerns such as rent
concerns such as rent seeking behavior, the nature of monopolies and issues of monetary and fiscal policies.
The Federal Reserve or the fed is the institution within the United States that plays the role of a central bank in many other states across the globe.
The Federal Reserve was formed by an act of congress in 1913. Its main objective was to provide the nation with a more secure, flexible, and more stable monetary and financial system. The Federal Reserve is not only restricted to formulating the monetary and financial policy but also is also involved with the general formulation of policies within the government sector.
This is usually so, so that the government ministries do not implement policies that may override the projections set forth by the Federal Reserve. Over the years, the fed has seen the economy through the great depression, the two world wars as well as guiding the economy to become the largest economy in the world.
In this analysis the concerns of the political economy of the Federal Reserve revolves mainly around the three major economic tools that the Federal Reserve uses in order to accomplish its objectives. These issues are discussed below.
OPEN MARKET OPERATIONS (OMO):
Open market operations involve activities like selling and buying of government bonds or treasury bonds. The sale of treasury bills to the banking sector or to the public is usually meant to reduce money supply in circulation while the purchase of the same from the public is meant to increase money supply.
When the public purchases the treasury bonds, they actually pay up the money to the government. Once the money is paid up, the money supply in the economy reduces by the equivalent amount. By doing this, the Federal Reserve may have intended to raise the interest rates.
The reserve requirements refer to the proportion of private deposits that the Federal Reserve requires commercial banks to deposit with the fed. To increase or reduce the money supply within the economy the Federal Reserve either reduces or increases this ratio respectively. In addition changing the reserve requirement directly affects the money multiplier that determines the amount of money that commercial banks can convert into loans within their existing deposits.
THE FEDERAL FUNDS AND DISCOUNT RATES:
Over the last decade, the fed has increased its focus on the central funds rate (the interest rate charged by commercial banks on over night lending) as a primary indicator of a stance of monetary policy. To accomplish this, the fed announces a federal funds rate target of each F.O.M.C meeting.
By regulating the over night lending rates the federal reserve indirectly regulates the money supply since the general prevailing interest rates will actually rise or fall depending on whether the fed intended either of this to happen. By regulating the federal funds rate, the fed also implements changes that may or will reduce challenges for banks to get loans but at the same time, it may hamper the availability of the funds by raising the price of the loans.
Benjamin, J. Cohen. 2007. ‘The transatlantic divide: Why are American and British IPE so different?’ Review of International Political Economy, Vol. 14, issue No. 2, May 2007.
James E. & Shepsle Kenneth (eds.) (1990), Perspectives on Positive Political Economy .Cambridge: Cambridge University Press.
Krueger, Anne O. “The Political Economy of the Rent-Seeking Society” American Economic Review, 64(3), June 1974.
Mayer, Charles. 1987. In search of Stability: Explorations in Historical Political Economy. New York: Cambridge University Press.
The Federal Reserve official website available at: http://www.federalreserve.gov
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