Federal Reserve, Money supply and Inflation By-

About Federal Reserve Ben Bernanke serves as the current Chairman of the Board of Governors of the Federal Reserve System. The Federal Reserve System is an independent entity within the government, having both public purposes and private aspects. It’s an independent authority as its financially independent and also has authority to take the decisions on its own. But it has to work within the framework of the objectives of the government.

Federal Reserve The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy. (Wikipedia) The Federal Reserve controls the three tools of monetary policy: Open market operations, the discount rate, and reserve requirements. The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals.

Decision makers at Federal Reserve The Federal Reserve System is a quasi-governmental banking system. Its composition is as follows: (1) Presidentially-appointed Board of Governors of the Federal Reserve System in Washington, D.C. (2) The Federal Open Market Committee; (3) 12 regional Federal Reserve Banks located in major cities throughout the nation; and (4) numerous private member banks, which own varying amounts of stock in the regional Federal Reserve Banks.

Monetary Policy The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals.

Tools of monetary policy Thus the three ways in which the federal reserve can change the money supply are 1. Change in Bank Rate (Fed Fund Rate) 2. Open Market operations like buying and purchasing of government securities 3. Change in Variable reserve ratio

Increase in Money Supply 1. Reduction in bank rate, specific interest rate on loans and savings 2. Buying of government securities from bank to increase the money supply 3. Reduction in the variable reserve ratios like statutory liquidity ratio and cash reserve ratio. (Mishra & Puri) If the Federal Reserve is going to adjust all of these tools during an during an economic recession, the changes they would make will be to increase credit and to increase the money supply to increase the economic growth, then it would do the following: 1. reduction in bank rate,  specific interest rate on loans and savings 2. Buying  of government securities from bank to increase the money supply 3. Reduction in the variable reserve ratios like statutory liquidity ratio and cash reserve ratio. (Mishra & Puri)

Inflation In economics, inflation is an increase in the general level of prices of a given kind. General inflation is referred to as a rise in the general level of prices.

Measuring Inflation Use of price index system for measuring inflation. For example, The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services As an economic indicator. As the most widely used measure of inflation, the CPI is an indicator of the effectiveness of government policy. In addition, business executives, labor leaders and other private citizens use the index as a guide in making economic decisions.

Causes of Inflation Cost Push Demand Led "Inflation can result from a decrease in aggregate supply. The two main sources of decrease in aggregate supply are     * An increase in wage rates     * An increase in the prices of raw materials These sources of a decrease in aggregate supply operate by increasing costs, and the resulting inflation is called cost-push inflation. It is also known as  supply-shock inflation is a type of inflation caused by large increases in the cost of important goods or services where no suitable alternative is available. The causes of cost-push inflation can be scarcity of factors of production such as steel, oil etc or there may be increase in demand of factors of production. Definition of Demand-Pull Inflation Parkin and Bade give the following explanation for demand-pull inflation: "The inflation resulting from an increase in aggregate demand is called demand-pull inflation. Such an inflation may arise from any individual factor that increases aggregate demand, but the main ones that generate ongoing increases in aggregate demand are    1. Increases in the money supply    2. Increases in government purchases    3. Increases in the price level in the rest of the world

Impact of Natural Disasters The impacts of natural disasters are recessionary in nature. This is because it creates loss to the nation as it leads to massive destruction in loss of assets. For example If a person has lost a house worth $1,000,000 during the hurricane. After the hurricane, this asset will not be there in his balance sheet. Thus this will be his loss and loss to the economy. Thus this causes depression and reduction in the purchasing power. Thus this leads to the reduction in the prices and consequently deflation. Hence the effect of the natural disaster in the economy is inflation. http://www.utdallas.edu/~sxb030200/sb_cp3_nat_disasters_122005.pdf.

Costs of Inflation It leads to uncertainty about the value of money It can lead to recession It can hurt the productivity

Fear of Inflation Can destabilize the economy Can lead to reduction in Purchasing Power Inflation is feared because it leads to uncertainty about the value of money - the future prices of goods and services - can be damaging to the proper functioning of the economy. When prices across the economy are fairly stable, specific changes in the prices of individual goods and services allow firms and individuals to make decisions about how much to consume, how much to produce and invest, and how much to save or borrow. These price changes are reasonably clear to see; they are not obscured by a general rise in prices. When the prices of most goods and services are rising, it is more difficult to know which items are rising in price relative to others. This often results in large falls in output - ie a recession - as the imbalance in the economy was abruptly corrected. One of the costs of unsustainably high output growth - an economic boom - and the resultant upward pressure on costs and prices, has been large falls in output and employment. Thus it also leads to greater instability in the economic conditions. Thus inflation leads to reduction in employment and increase in wage rates. There is reduction in employment because of recession and increase in the wage rates in the economy.

References www.bls.gov Mishra & Puri , MACRO ECONOMICS. Sultan Chand & Sons www.americanchronicle.com/articles/viewArticle.asp www.economics.about.com www.investopedia.com www.en.wikipedia.org