One of the major uses of money is that it is a standard of deferred payments. This implies that based on the legal acceptance of money, it is used to settle debts. Federal Reserve Bank has adopted the electronic payment systems in the form of credit cards and debit cards in its effort to improve the processes of settling of debts. According to the Federal Reserve Bank financial report (2010) use of debit and credit cards has been adopted in order to avoid the risks associated with carrying liquid cash. Even though there is interchange fee associated with the debit and credit cards, these modes of payment are safe and less tiresome. Another use of money is that it is a store of value. This implies that money can be stored or retrieved without losing its value. In this regard, Federal Reserve Bank has instituted various forms of accounts in which the customers can deposit their savings. In this way, customers can earn interest on their savings. For instance, the bank has maintained personal accounts such as simple savings and individual retirement accounts. In addition, the federal bank has a legal right to maintain reserves on behalf of other banks in order to regulate the money supply. The ability of the money to store value is affected by the inflation or depletion.
Money is also used as a medium of exchange. This means that it is used during the exchange of services and goods. In this regard, the negativities of the double coincidence of wants which are experienced in the barter system are entirely avoided. Federal Reserve Bank regulates the value of money in order to ensure that business transactions are not jeopardized by the economic inflation or recession.
Banks create money when they lend to their customers. Banks give loans to the customers in order for the customers to repay them in future. In order to ensure that enough money is generated to oversee their operations, banks charges interests on the loans given to the customers. The rate of interest charged mostly depends on the amount of the loan and the repayment period.
Federal Reserve Bank is an independent entity of the US government. This is based on various factors. First, the bank budget is only determined by the Fed Board without any form of political interference. Secondly, the employees of the Fed are not covered by the health insurance and pension programs which have been put in place by the US government. This is a clear indication that the bank is independent. Thirdly, the organization of the bank is not within the judicial, executive or the legislative branches of the US government.
Fed uses three major tools to control the money supply. The first tool is open market operations (OMOs). During inflation the government sells bonds and securities to the public in order to reduce the money supply, while during deflation the government buys the securities in order to increase the money in circulation. FOMC (Federal Open Market Committee) is responsible for the undertaking of the OMO either in the form of reverse repurchase agreements or repurchase agreements. The second money supply regulation tool is the discount rate. This is the interest rate charged to other banks on the loans they obtain from Federal Reserve Bank. During inflation, the federal bank increases the discount rate in order to discourage other banks from borrowing, thus decreasing the level of inflation (Sullivan and Steven, 2003, p.2). The third tool that is used by Fed to control money supply is the reserve requirement. This is the amount of fund which is the Federal Reserve Bank holds on behalf of other banks against a certain amount of deposit. During deflation, Fed decreases the reserve requirements in order to increase the liquidity of the depository institution thus increasing their abilities to give more loans leading to an increase in money supply. On the other hand, reserve requirement is increased during inflation to reduce money in circulation.
Expansionary policies are monetary strategies which are adopted by central banks or Federal Reserve Bank in order to increase money in circulation. On the other hand, contractionary policies are monetary techniques which are aimed at reducing money in circulation. When bank increases interest rate, customers are discouraged from borrowing thus leading to low level of investments and reduced employment opportunities. An increase in the money supply on the other hand, pushes the interest rates upwards leading to low level of public borrowing and reduced level of investment. Banks can encourage economic growth by reducing interest rates so as to encourage public borrowing. This is based on the fact that, increase in borrowing leads to more investments and creation of more job opportunities. Through the reduction of money supply, interest rates are increased in order to encourage savings and discourage borrowings this leads to low level of economic growth.
Sullivan, A. Steven, M. (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. Web.
Information on Federal Reserve Bank monetary policies.