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The FED and Aggregate Demand

TheFED and Aggregate Demand

TheFed is the U.S’ central bank, and it has a constitutional mandateto regulate the nation’s finances. The major goals of the Fed areto maximize employment and sustainable output and to stabilize pricesin the market. The Fed achieves these goals by regulating the federalfunds rate, which in turn regulates interest rates. This manipulationis responsible for the stimulation and suppression of the economysuch that the economy’s growth is regulated. This paper exploresvarious ways through which the Fed stimulates the economy of thenation.

TheFed uses a monetary policy to regulate the federal funds rate. Themonetary policy gives the Fed power to regulate financial supply inthe U.S. Manipulation of this rate affects banks since it determinesthe interest rate which banks charge each other when borrowing moneyin order to meet the reserve requirements set by the Fed. This inturn affects the interest rates that the banks set when lending moneyto consumers. Manipulation of the interest rates also influencesemployment rate, inflation rate, and manufacturing output. Thus, theFed stimulates the economy indirectly and in the short term bylowering the federal funds rate through a monetary policy. Threemonetary policy tools help the Fed to stimulate the economy. Theseare the discount rate, the open market requirements, and the reserverequirements. In order to stimulate the economy, the Fed sets lowreserve requirements for banks and a low discount rate henceincreasing borrowing from the Fed reserve. This decreases borrowingacross banks hence lowering the federal funds rate, which indirectlyreduces interest rates. This increases the money supply and leads tohigh employment rates, high output, and low inflation indirectly(Besley and Eugene 183).

Acontinued stimulus to stimulate the economy implies a constantdecrease in federal fund rates and interest rates. This also leads toan increase for money in circulation. On the other hand, rising oilprices increases the interest rates as it leads to high product andservice prices. These two events counter each other since Fed has todecrease the interest rate in order to stimulate the economy whileincreases in oil prices increase the interest rate. In this case, theFed will need to implement the fiscal policy alongside the monetarypolicy. Here, the government will be required to increase itsfinancial input in supporting production and manufacturing processes.This support will reduce the production rate and counter the high oilprices. This will stimulate the economy without reducing the interestrate and this will in turn reduce the oil prices (Besley and Eugene157). I believe regulating the foreign exchange rate will alsostimulate the economy and reduce the oil prices. The Fed will need toimplement a balance of payment in that the export rate will exceedthe import rate. This will increase the value of the U.S dollar andthus reduce the cost of importing oil. Fed will then implement themonetary policy to increase the interest rate and stimulate theeconomy. Therefore, the oil prices will be regulated withoutaffecting the nation’s economic growth.

Inbrief, the Fed has the constitutional mandate to regulate thefinancial resources of the U.S. they achieve this by implementingthree monetary policies, that is, discount rates, open marketrequirements, and Federal Reserve requirements. Fed stimulates theeconomy by reducing the reserve requirements and the federal fundrates. This works indirectly as it leads to a reduction in interestrates.

WorksCited

Brigham,Eugene F, and Joel F. Houston. Fundamentalsof Financial Management.Mason, OH: South-Western Cengage Learning, 2009. Print.

Besley,Scott, and Eugene F. Brigham. Principlesof Finance.Mason, Ohio: South-Western, 2008. Print.