Federal Reserve

During the history of the Federal Reserve it has been our policy to change the countries money supply by traditionally purchasing government bonds to increase the money supply or sell government bonds to decrease money supply. When the Federal Reserve purchases government bonds this naturally causes an increase in the money that is available to the nation’s banks giving them more opportunity to make loans. This also has the tendency to lower interest rates which increases investment spending and overall increases the GDP. On the other hand when the Federal Reserve sells government bonds this will decrease the money supply available to banks lowering the amount of loans they are available to give. This will have the tendency to increase interest rates which decreases investment spending and overall decreases the GDP (O’Sullivan-Sheffrin, 2006).

An example of how this increase works is as follows. If the Federal Reserve buys government bonds the money that is put into the account of the purchaser will grow from its original amount. If the Federal Reserve buys the bonds for 1 million dollars the bank will maintain a certain percentage in reserve liabilities which depending on the banks net deposits will range currently from 3% to 10% (Federal Reserve Board). For this example we will use 10%, so the bank must keep $100,000 in reserve but the rest may be loaned out or used by the account holder. This money may branch off to numerous other banks these banks will also take out what percentage must be held in reserve liabilities and use the rest. This chain will continue and in each situation it will increase the money supply by a smaller percentage in each situation.

With this information on how the Federal Reserve currently works we will now go over the possibilities of the Federal Reserve looking at purchasing stocks on the New York stock exchange. In the realm of things it is possible for the Federal Reserve to conduct monetary policy or the influencing of the GDP and the inflation rate through

the purchasing of stocks. The concept is similar to the purchasing of government bonds with some minor adjustments. The Federal Reserve in the process of purchasing stocks will still be placing additional funds into the money supply circle, weather they will be purchasing new stock from a company or existing stock already on the market. In either case the company or the person receiving the funds will use that money to consume something or place it into the banking system (Wikipedia Encyclopedia).

If they were to sell their shares then they would be decreasing the funds in the money supply circle by receiving payment from either a company or a person. This money would come from some banking account and decrease the reserves in which that bank and all other banks would have at their disposal. So you see it would be the same except the Federal Reserve could make a profit from this system either through

dividend payments or by selling the stock at a hirer rate of the original purchasing price. Or they could take a loss if they sold the shares at a lower rate of the original price. This is different than dealing with bonds as they would gain no profit from the selling the bonds or loose any profit when they purchase the bonds.

This policy would give the Federal Reserve another tool to use in trying to control the economy but it has some issues that must be addressed. First if you look at the Federal Reserve you are looking at a government agency, it can not be controlled by the government but the Chairman of the Federal Reserve and the other seven members are appointed by the President of the United States (O’Sullivan-Sheffrin, 2006). So they do have political connections and political clout,