Objectives of Federal Reserve System | Quantitative Easing | Investment Analysis
U.S Federal Reserve System (Fed)
Fed is considered to be the world’s most powerful central bank which provides the nation with a safe, flexible, and stable monetary and financial system. Fed was established after the crisis of 1907 after the repeated financial panics and economic disruptions that hit the US economy which led to calls for an institution that would prevent these panics and disruption in the economy (CHEN, 2020).
Main Objectives of U.S Federal Reserve
Fed’s main objective is to promote healthy economy where unemployment is lower, inflation is stable and lower, and financial system which can fulfill the credit need of the economy. The major objectives of U.S Federal Reserve are as follows:
- To conduct nation’s Monetary Policy.
- To maintain the stability of the financial system.
- To promote safety and soundness of individual financial institutions.
- To foster payment and settlement system safety and efficiency, and
- To promote consumer protection and community development.
How Fed achieves these objectives?
By implementing various monetary policies (Contractionary and expansionary) as per the requirement of money supply in the economy. Fed uses different monetary tools (Reserve Requirements, Public Debt Policy, Open Market Operations, Discount Rate, Directives, and Interest Rate Controls) for controlling the money supply in the economy. Fed helps in achieving and maintaining stability of the financial system by properly regulating and supervising these institutions. Fed achieves this objective by also encouraging the financial and economic literacy to the people, promoting the equal access to credit for all. Along with this Fed works with communities, non-profit organizations, etc. for uplifting the economy of the local level as well.
Advantages and Disadvantages of Quantitative Easing (QE) as an alternative to conventional monetary policy when short-term interest rates are at the zero-lower-bound.
Quantitative Easing (QE) is a tool for unconventional monetary policy used by the central banks whereby the central bank of the country purchases the financial instruments from the market to increase the money supply in the economy and expand the economic activities (lending and investment). Quantitative easing is mainly implemented in the scenario where interest rates seems to be approaching zero because the central banks have limited tools that fosters economic growth at this time (CHAPPELOW, 2020).In normal condition the conventional monetary policies does helps to solve the problem of money supply but during the time of economic crisis when there is immediate need for the boost of economic activities other non-conventional monetary policies like Quantitative Easing are adopted.
Advantages of Quantitative Easing
When short term interest rates are at zero-lower bound, Quantitative Easing is used as an alternative to conventional monetary policy where long term financial securities are purchased from the market increasing the liquidity in the economy. QE gives an immediate result and is considered to be the best practice to drain non-functioning assets from the market.
Disadvantages of Quantitative Easing
The disadvantages of quantitative easing are that it can lead to inflationary pressure in the economy because of the availability of easy credit. At first the adoption of QE creates boom and expansion but as soon as the crisis goes on normal the businesses diverts from the expansionary phase to Contractionary phase. QE decreases the interest rates ultimately increasing the bond and stock prices in the market which negatively affects the pension funds earnings as well.
Composition of the Fed’s balance sheet a potentially important aspect of monetary policy during a crisis
The Fed’s balance sheet includes a large number of distinct assets and liabilities which contains a great deal of information about the scale and scope of its operations. The evolution of Fed’s balance sheet has been closely studied by the market participants for decades to understand in a clear manner regarding the important details concerned with the implementation of monetary policy. The complexity of Fed’s balance sheet has been increased because of the implementation various new lending facilities to address the financial crisis.
Fed takes into account the effect of its balance sheet on the economy while expanding or contracting its balance sheet. Fed’s balance sheet management continues to evolve as per the changes in the economic and market events (Wise). Since the Great depression the balance sheet of Fed has gone through various phases like, it has implemented Quantitative Easing, Balance Sheet “Normalization” ,move toward U.S. Treasury-centric balance sheet, etc.
CHAPPELOW, J. (2020, April 28). Quantitative Easing (QE). Retrieved from Investopedia: https://www.investopedia.com/terms/q/quantitative-easing.asp
CHEN, J. (2020, May 4). What Is the Federal Reserve System (FRS)? Retrieved from Investopedia: https://www.investopedia.com/terms/f/federalreservebank.asp
Wise, T. (n.d.). FEDERAL RESERVE BANK & MONETARY POLICY. Retrieved from Banking Strategist: https://www.bankingstrategist.com/fed-monetary-policy-balance-sheet