Economics – the Federal Reserve
Essay Preview: Economics – the Federal Reserve
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The Federal Reserve has 5 tools of monetary policy which can increase or decrease the quantity of money currently in circulation and can affect interest rates. The first tool the Federal Reserve uses is what is known as “Quantitative Easing.” This is when the Fed purchases ten year Treasury securities and credits the account of the seller which are new reserves that are owned by the seller. This allows the selling bank to lend newly-created money as a result of the new excess reserves that have been “created” and purchases on the open market by the Fed increase the quantity of money in circulation. If the Fed were to sell any asset, the quantity of money would decrease. The Fed changes the amount of reserves in the banking system daily by purchasing or selling government securities. This change in reserves causes the change in money circulation. The second tool is changing the discount rate charged by the Fed to any financial institution which bowwows reserve deposits or the Federal Funds Rate. Banks must end each day with a required amount of reserves on their account. If a bank is short, it must borrow reserves from the Fed to remain legal. The increase in reserves increases the quantity of money in circulation. A bank that is short on the required amount of reserves has lent out too much, causing the quantity of money to be larger, and the raising of Fed funds rate will curtail such excess money creation. The Fed gets control over the quantity of money by adjustments to the discount rate or to the Fed Funds rate. The third tool the Fed uses is the changing of the reserve requirement ratio. Banks must maintain a certain ratio, and a lower required reserve ratio causes reserves to be lent, causing the increase in the quantity of money in circulation. A higher reserve ratio has the reverse effect. The Fed has begun paying interests to banks on the reserves held by the banks at the Fed. This tends to increase the quantity of excess reserves. The fourth tool is the “Overnight Reverse Repurchase Agreements.” The Fed uses so-called reverse repos to soak up cash from money-market mutual funds and other nonbank financial institutions and pays them interest in return. The interest rate that the Fed sets on these instruments will gradually rise as the Fed raises its rates. The fifth tool is the changes in Interest Rate paid by the Fed on Reserve Deposits with the Fed by banks. This was created in order to keep banks from lending their excess reserves and increasing the quantity of money in circulation and causing server price inflation.
2. The “Roundaboutness” of production is causally related to the value of the product. The longer the production, the better and the more highly valued the product is. However Bohn-Bawerk does not exactly say that longer production for the sake of longer production is valuable, instead he says that longer production is only employed when the estimations of the increase in the value of the product exceed the increase in the costs associated with waiting. Manipulation of interest rates messes up consumer and producer valuations of time, capital, and production. When a longer production process is made to look more profitable, and saving is made to look less profitable, a rerouting of capital occurs. Capital gets diverted into longer and longer production processes, while consumers increase their expenditures on final goods and services. This eventually drives up the costs of production as a whole. Once this unitability is realized, the market crashes. Employment , wages, consumer pay for prior indulgences , and economic activity as a whole goes down. Lengthening of the structure of production increases the degree of roundaboutness and also increases the time-duration of the production process.
3. The misallocation of capital comes from an artificially low rate of interest. By interfering with the choices and activities of market participants, production process has become too time-consuming in relation to the temporal pattern of consumer demand. The misallocated