The Federal Reserve’s definition of money goes beyond being a medium of exchange. It defines money in terms of measurements that range from one to five (M1-M5). The measures are interpretive of other definitions of money such as a store of value and standard of value. As a regulatory and monetary policy formulating institution, the Federal Reserve control money in the U.S. by managing the money supply. This supply is defined as “a group of safe assets that households and businesses can use to make payments or to hold as short-term investments (Federal Reserve, n.d, para. 1). However, M1 and M2 is the monetary base of the volume of money in the country at a given period. In table 3 (H6, p.3), of the Money Stock Measures, for the last three months, the seasonally adjusted M1 is 506.2, 508.1, 511.4 respectively. The seasonally adjusted M1 for the last one year is 9.1. The largest components of M1 are the currency, traveler’s checks, demand deposits and other checkable deposits. While those of M2 are savings deposits, deposits in an amount less than 100,000, and retail money funds.
The functions of money fall within its definition as a medium of exchange, store of value, and standard of value. Economics is the study of choices through goods and services. Needs and wants are met when there is an exchange of money. If one needs a weekly hairdo it is the hairdresser who will exchange skills for one's money. The skill and the hairdo had to be exchanged through the medium called money. Winning a lottery and deciding to save the cash until the fiftieth birthday is a demonstration of how money can be a store of value. And seeing land as a means of production, the conversion of a certain amount of the lottery to the purchase of a piece of land that appreciates over time depicts money as a standard of value.
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The problems of inflation, unemployment, and instability in prices are critical to the objectives of the Federal Reserve. Through the use of money supply information, the institution can gauge the performance of the economy. Thus, the Fed meets frequently to undertake reviews of the macroeconomic indicators and the monetary policies. Monetary policies of the Federal Reserve take two shapes. One is to control negative price changes by developing contracting or tightening policies. These policies are targeted at keeping inflation at the bear minimum and reducing and restoring prices of goods and services. The contractionary policy keeps the money supply low. On the area of maintaining a complete employment strategy and sometimes long-term economic growth the Federal Reserve applies the expansionary policy. This policy option is the apparent opposite of the contractionary policy. It enables certain levels of transactions and federal fund rates to be at levels that boost economic activities and employment. In other words, a sufficient level of currency is available in circulation.
Money supply is effectively controlled and regulated by the Federal Reserve using the bank reserve requirement, discount rate, and the open market operations. The reserve requirement is the monetary lending cap that is given by the Federal Reserve. It stipulates the amount that banks cannot exceed in lending. It has an inverse relationship with inflation and interest rates. Raising the bank reserve requirement reduces inflation while lowering it increases the interest rate boosting investment and the economy. Thus, raising the reserve requirement minimizes banks capabilities to borrow and lend money leading to reduce inflation.
The discount rate acts as a form of a determent to banks. It disincentivizes banks from accessing money at the Federal Reserve. It is a short notice, crisis-driven alternative means of borrowing by banks. The Fed uses this tool when fighting and regulating inflation because raising it will discourage borrowing while lowering it makes borrowing easier. And because the result of lowering it raises the inflation level the Fed usually raises it to a level that minimizes the negative effects of raising it above bearable levels. The Federal Open Market Committee (FOMC) is the principal organ of the Fed that oversees the operationalization of the open market activities. It buys and sells securities in the open market on behalf of the central bank. This is done at the trading platform supervised by Fed bank of New York. The Open Market Operations (OMOs) commonly applied in trading are the repo and securities. The Fed uses OMOs to monitor and change short-term interest rates and controls inflation through government owned securities.
Policymakers experience a time lag from the period when a policy is formulated to the time of its implementation. Often, the policy takes months before it is implemented ( Goodhart 2001). This is because the government is seen as a system that is slow in responding to economic matters. So, monetary policy lag have been classified into inside and outside lags. Inside lags refer to the time of identification of the economic problem to the period when the right policy steps are taken to address it. The outside lag is the time frame from the provision of the solution to its meaningful effect on the general economy. Inside lags involve recognition, decision, and implementation lags. Recognition is about identification, the decision is coming up with a policy, and implementation is about ensuring that all organs involve participate and corporate with the process. In the outside lag is the impact lag. It represents the time when businesses and consumers will begin to experience the effect of the monetary policy. This usually takes longer than the other lags. The study of lags is important because it provides policymakers with some working frame on how long a policy will impact the economy. Also, the factors that affect the transition from the decision to impact will be very useful in policy formulation. It will help in budget preparation as well control of the money supply.
Federal Reserve monetary policy can affect one socioeconomically. The control of the amount of money in circulation is critical to prices stability, unemployment, and the lending rates from banks. The control of the macroeconomic factors means that wrong and untimely policy decision will take some time to recover. And the country can face a recession because of the response of the Federal Reserve.
References
Federal Reserve (n.d). Money. Retrieved from http://www.federalreserve.gov/faqs/money_12845.htm
Federal Reserve. (2016). Statistical release
Goodhart, C. A. 2001. “Monetary Transmission Lags and the Formulation of the Policy Decision on Interest Rates.” Review (Federal Reserve Bank of St. Louis) 83 (4): 165–86.
