Introduction

The collective governance of 12 Federal Reserve banks in the United States is referred to as the Federal Reserve System. The Federal Reserve Bank is one of the most important controlling authorities in the US banking sector. There are various duties the bank performs to regulate the banking industry. It is mainly associated with policy-making, implementation of those policies and keeping a close check on member banks. Apart from these operations, the Federal Reserve also exercises strong control and vigil over the United States financial system. There are various roles defined for the Fed however, in reality, the Fed is really the “czar of the United States financial system”.

There has been growing speculation that the Federal Reserve System is constantly creeping up the power ladder in the US economic system. While politicians would like to see the Fed sidelined allowing them greater manipulation of the economic system, there are strong hardliners who would love to see the Fed involved in almost every transaction. The aim of this paper is to present a well-balanced essay on the advantages and disadvantages of the Federal Reserve Bank and its role as the supervisory authority of the US financial sector.

Background

Before beginning the attempt to understand the role of the Federal Reserve Bank as the sole authority of the US financial system, it is important to gain a brief understanding of the workings of the Federal Reserve and its workings. Contrary to popular speculation and belief that the Federal Reserve Bank is a part of the federal government, the Federal Reserve is actually owned by the private banks that operate within the US. The responsibilities of the Federal Reserve can be broadly categorized into the following:

®  Regulate the Banking Industry through laws and policies (accountability bureau).

®  Framing monetary policies and using money supply, open market operations and required reserve ratios as tools to implement them.

®  Maintaining price stability and sustainable economic growth.

®  Lender of the Last Resort for member banks.

®  Contractual Clearing Balances.

®  Financial Disclosure of member banks.

The above responsibilities primarily lead to the conclusion that the Federal Reserve is actually one of the most supreme authorities in the US financial sector. Banks and financial institutions are required to act according to the directives issued by it and there are heavy penalties levied on defaulters. There are set rules and policies on each and every matter regarding banking and financial functioning. At times, many financial institutions detest too much involvement of the Federal Reserve in their business. However, there is not much that they can except for adhering to their terms and conditions in order to avoid problematic situations with the Fed.

Considering the heavy amount of involvement of the Federal Reserve in the affairs of banks and financial institutions, in general, in the US economy, it is highly debatable whether these actions have a positive or negative impact. This paper will be discussing in turn the positive and negative aspects of the undisputed authority of the Federal Reserve in the financial system of the United States.

Powers of the Federal Reserve

Apart from the roles and responsibilities the Federal System possesses, there are special powers that rest with the Federal Reserve. The Federal Reserve basically has all the powers to regulate the entire financial industry of the US. The Fed has three tools, which it uses to execute its pan in order to achieve its goals. Even if certain powers do not rest directly with the Fed, it has been able to manipulate and influence activities in those sections through effective use of its three major tools. Monetary supply, Required Reserve Ratio (RRR) and the Discount Rate (also referred to as the Overnight Lending Ratio) are the Fed’s three most effective and powerful tools using which it can control market interest rates, inflation, unemployment and the economic growth and stability of the US economy.

Though the normal man may not be aware of the extent to which the Federal Reserve can influence and manipulate their lives, the truth is actually that there is a say of the Fed in almost every financial deal in the US. The power of making policies governing trade, banking and interest rates lies with the Federal Reserve. Banking policies are comprehensive in that they include all aspects of it – human resource, consumers, mergers and acquisitions, etc. Since, the Federal Reserve is a historically active body with several decades of experience and activity in the financial sector it is not influenced by the presence of any major dominator in the industry. Rather, the Federal Reserve itself is the dominating player in the financial sector. The following pages will examine the advantages and disadvantages of the vested power of the Federal Reserve and seek to conclude whether the extent of this power is really for the growth and prosperity for the United States financial sector or whether it has a deteriorating effect on it.

Advantages

Imagine a room of small young kids with an abundance of toys to play without any supervision. What happens when there is no supervisor? The children will try to take as many toys to themselves as possible and there might emerge loyal friendships amongst groups of kids as well as bitter fights. Without any teacher, there is likelihood of the classroom turning into a chaotic hub and will require the attention and intervention of a neutral body soon enough. No, this is not a scene from a children’s nursery. Rather this would be really the scene of the US financial sector if there was no Federal Reserve. The likening of the small children in the room with the individual banks and financial institutions is highly appropriate if the toys are the consumers and financial profits. Just like kids would play with as many toys possible at the same time, the financial institutions would also like to earn as much business profits as possible. The absence of the supervisor or teacher is like the absence of the Federal Reserve.

A situation similar to the one obtained in the classroom would prevail in the US financial sector if there would be no Federal Reserve. There would be financial mergers between companies having good relationships resulting in the formation of major consortiums and big players in the market. There would be quarrels and inevitable enrichment of one group on the interests of another group.