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What is the role of the federal reserve? When and why does the federal reserve increase and...

Question:

What is the role of the federal reserve?

When and why does the federal reserve increase and decrease interest rates?

Choose a specific industry (ie/ automotive, real estate, electronics, banking, etc.) and describe how that industry would be affected by the Federal Reserve's decision to increase or decrease interest rates.

Federal Reserve:

It is the central bank of the US, which is responsible for formulating the monetary policy, regulates money supply and rate of interest in the economy. It determines the reserve requirement rates for the commercial banks. The main aim is to stabilize the economy directly or indirectly.

Answer and Explanation:

The role of the Federal Reserve is to:

1. Supervise the other commercial banks in the economy and ensure the smooth running of the banking system in the economy. It can regulate the commercial banks actions through reserve requirements and moral persuasion.

2. Manage inflation and recession through expansionary and contractionary monetary policy. It makes the monetary policies for the economy and controls the entire nation?s money supply.

3. The fed also have the control over the foreign reserves and ensure a stable exchange rate for the country.

When the economy is under inflation the Federal Reserve will increase the rate of interest in order to restrict the ability of commercial banks to credit loans. It will reduce the supply of money in the economy. Thus, the aggregate demand will fall and ultimately leads to a fall in the general price level in the economy.

On the other hand, when the economy is in recession, the fed will reduce the reserve requirement rates which will increase the ability of the commercial banks to credit more loans. It will further lead to increase in the money supply and aggregate demand in the economy.

For instance, when the Federal Reserve will decrease the rate of interest, the people will borrow more as more money will be available in the economy. It will increase the aggregate demand in the economy. The households will be able to purchase more goods such as electronic items and thus, will increase the demand for electronic goods. It will further increase the supply and profits of electronic industry in the economy.


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What is the Federal Reserve System?

from Economics 102: Macroeconomics

Chapter 12 / Lesson 1
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