Monetary Policy and the Federal Reserve essays

Monetary Policy and the Federal Reserve essays Money doesnt grow on trees. How often has one heard that cliche? But if horticulture cannot produce dollars and cents, then how is money created? One rather flip answer might be that moneys value is created because the government says so. Despite the sarcasm inherent in this comment, there is a trace of accuracy to the statement. Money is essentially an empty thing, a placeholder rather than a substance of actual value. Once upon a time, the gold standard held sway, meaning that all U.S. funds were backed by gold held in the vaults of Fort Knox. However, this is no longer the case. The abandonment of convertibility of money into a commodity since August 15, 1971, when President Nixon discontinued converting U.S. dollars into gold at $35 per ounce, causing most other nations to follow suit, has made the U.S. and other countries' monies into fiat money-money that national monetary authorities have the power to issue without legal constraints. (Schwartz, 2002) To prevent the willy-nilly printing of money and inflationary growth, the Federal Reserve enforces certain constraints upon the circulation of money. For example, the Federal Reserve requires commercial banks and other financial institutions to hold as reserves a fraction of the deposits they accept. Banks hold these reserves either as cash in their vaults or as deposits at Federal Reserve banks. (Schwartz, 2002) This policy was put into place partially to prevent bank runs, or the phenomenon of people being unable to borrow money because the bank had lent such a wide percentage of available dollars to other patrons. To manipulate the amount of circulating currency in the economy, the Federal Reserve can either raise or lower the national reserve requirement for member banks. If banks must hold a higher level of funds in reserve, the banks will have less money to lend, thus the money su...