The Federal Reserve System is the central banking system of the United States. The purpose of the Federal Reserve is to strengthen the financial system. The Federal Reserve has several responsibilities it must perform in order to maintain the flow of money in America. These tasks include supervising and regulating banks, maintain a strong payments system, control the amount of currency that is made and destroyed on a day to day basis, and to implement a monetary policy (The Federal Reserve Board, 2003). It is the monetary policy that is the most important task of the Fed. The monetary policy consists of open market operations, reserve requirements, and discount window lending, what is commonly known as the discount rate (Federal Reserve Bank of New York, 2006). These three tools of monetary policy help to add security and control the economy of the United States by influencing the outcomes of inflation, economic growth, and unemployment.
The first tool of monetary policy to explore is the use of reserve requirements. The Federal Reserve requires a percentage of all deposits at a bank must be kept on hand at the bank or in a Federal Reserve Bank. The amount of cash the banks must have available is only a small fraction of their checking and savings accounts (Wikipedia.org, 2006). The reserve requirement may not seem significant but it does play an important role in our economy. A low percentage rate requires the banks to keep less money on hand allowing for more loans to be made which in turn fuels the economy. A high percentage rate requires the bank to keep more money on hand. This makes it harder for people to receive loans and causes a recession (Federal Reserve Bank of Richmond, ...