The Federal Reserve System & American Business

Financial institutions are important to our economy and business in the United States because they increase the amount of money that is available for Americans to use. Ultimately, individuals make deposits into financial institutions and these institutions, in turn, can loan out the majority of each deposit to new people (while still owing the depositor the same amount of money). Any money from this loan that is deposited into another bank can be loaned out further by that institution, creating a seemingly endless supply of useable money (Ebert & Griffin, 2007). "Because commercial banks are essential to the creation of money, the government regulates them to ensure a sound and competitive financial system" (Ebert & Griffin, 2007, p. 472). One of the government agencies that helps to regulate these financial institutions is the Federal Reserve. The Federal Reserve System oversees many important aspects of the financial system in the U.S. Therefore, every business owner should have a basic understanding of the Federal Reserve (Ebert & Griffin, 2007).

But, what exactly is the Federal Reserve System? Basically, it is the "central bank system of the United States, which acts as the government's bank, serves member commercial banks, and controls the nation's money supply" (Ebert & Griffin, 2007, p. 473). The creation of a national financial system was a highly controversial issue in our nation's history that tended to divide Americans. Supporters of such a system tended to come from the thriving cities in Eastern parts of the U.S. On the other hand, small business owners, as well as farmers, particularly those operating in the South or West, were afraid that such a system would fail them in their time of need. However, since our nation continued to experience far too many depressions and other serious problems as a result of an inconsistent financial system, Congress finally opted to create a uniform and balanced system in 1913 through the Federal Reserve Act (Federal Reserve Bank of San Francisco, 2006).

The Federal Reserve System is an agency that operates almost entirely independent from the rest of the federal government. The Federal Reserve is required to inform Congress of its regular activities, as well as of any new plans it may have for the policies that oversee money in the U.S. Congress alone has the authority to alter the legislation that regulates the Federal Reserve System and its basic operations. However, Congress cannot directly control its daily activities and the Federal Reserve is designed to be financially independent so other government agencies cannot use funding as a means to manipulate it (Federal Reserve Bank of San Francisco, 2006). In the end, the Federal Reserve System consists of three different parts (1) a board of governors (located in Washington, D.C.), (2) twelve federal reserve banks (each established in a different key city across the U.S.), and (3) the Federal Open Market Committee, which consists of members from each of the other two parts (Joint Economic Committee, 1997, p. 3-4).

The Federal Reserve System's primary role is the manager of our nation's money. The Federal Reserve carefully implements policies that will adequately regulate how money flows in our economy, as well as properly manage the usage of credit in the U.S. This role is extremely critical to our economy because if money and credit are not managed properly, serious problems can occur across the nation. For example, if money and credit are not regulated enough and end up expanding at too high of a rate, businesses across the U.S. will have a very difficult time meeting the increased demand for their products. Often, this causes prices to soar, which ultimately leads to inflation. In contrast, if money and credit is too tightly regulated, then a recession may occur as the decrease in money supply causes a decrease in business. More specifically, the Federal Reserve regulates how much currency and coins are in circulation, circulating more money when there is a shortage and storing money when there is excess. The Federal Reserve also plays a critical role as regulator of financial institutions in the U.S., establishing and enforcing proper rules and regulations that will ensure banks do not misuse the money of their patrons. Finally, the Federal Reserve safeguards Americans' money even further by loaning money to those banks that experience an unforeseen event or temporary problem that causes (Federal Reserve Bank of San Francisco, 2006; Joint Economic Committee, 1997).

References:

Ebert, R. J., & Griffin, R. W. (2007). Business essentials (6^th ed.). Upper Saddle River, NJ: Prentice Hall.

Federal Reserve Bank of San Francisco. (2006, July). The Federal Reserve System in brief (Rev. ed.). Retrieved July 31, 2008, from http://www.frbsf.org/publications/federalreserve/fedinbrief/index.html

Joint Economic Committee. (1997, March). The importance of the Federal Reserve. Retrieved August 1, 2008, from United States House of Representatives Web site: http://www.house.gov/jec/fed/fed/fed-impt.pdf