There was a tremendous growth and development in the American financial sector in 20th century as the overall economy shifted from fiscal to monetary policy.The government has an independent US government agency known as the Federal Reserve System (Fed). This was founded by the United State government in the year 1913 to monitor and strengthen the banking sector which was previously dominated by panics.This was after a hotly debated session and a bill was signed by the then United States president Woodrow Wilson in December 1913. The idea was however to combat the competing interest of private banks in the US economy (Cohen, 2007). The Fed is known for its efficient open market operations in 1920s as it fully promoted its relationships with other nation’s central banks more so with the bank of England.
During the 1933 great depression approximately 10,000 banks failed and there was an urgent need of seeking a solution to this. Majority of people blamed Fed for the loss and they argued that the financial crash was as a result of its inadequate knowledge of monetary economics. According to them Fed ought to have speculated the depression and lower its lending rate (Warburton, 1966). However to counter this banks were required to use government securities as a collateral to the Fed. This strengthened the functional capacity of Fed and later made it one of the strongest independent units in the United States government.
The agency was mandated with the responsibility of making and implementing monetary policy amongst all nationally chartered banks. Fed maintained and controlled supply of money and credit in the economy through the use of certain tools. One was the open market operations where it increases money supply in the economy through by buying government securities from the banks and the public and paying them off with their newly printed money. On the other hand they reduced money supply in the economy by selling out government securities to the banks and public thus retaining the excess money into their reserves. The second tool which Fed used to regulate money supply was by raising or reducing the reserve requirements which banks ought to set aside.The third tool was the regulation of discount rate or interest rates which the commercial banks pay when borrowing money from the Federal Reserve Banks.
These three tools gave the Federal Reserve System power and authority to increase or reduce the amount of money in the economy. It also gave it power to regulate credit and spending level amongst consumers. For instance, an increased money supply in the economy tended to lower the interest rates and raise business and consumer spending. The credit level of the consumer’s increased as less was required to pay off the borrowed loans. Banks also had more money within their reach and thus they encouraged consumers to take loans at reduced rates. Additionally the unemployment level reduced if the economy was not operating under full capacity. However a lot of money in circulation led to inflation as it tends to lower the currency value. Alternatively, when an economy operated under a limited money supply, it increased the interest rates and lower spending rate. During this period, the credit level of the consumers reduces as they are required to pay more for their loans inform of interests. Inflation is also abated during this period while the unemployment level tends to rise.
In the 1950s, the American government through the Federal Reserve System implemented a restricted monetary policy with an aim of bettering the price stability of commodities in the economy (Friedman, and Meiselman, 1963). This was however so during the conservative administration. After the change of the administration in the year 1961, the liberal administration adopted a new expansionary monetary policy with an aim of improving the employment level and boosting the overall economic growth. The 1960s and 1970s was coupled with a rapid credit expansion which not only enabled the US government to combat the unemployment level, but also enabled it to register a significant economic growth (Block, 1977).The Fed during this time did what it could to increase money supply level in the economy. The credit demands raised and more people sort financial assistance from the various commercial banks.
The assumptions of the banking industry and the federal government werethat the increased of money supply and the latter credit expansion could greatly assist in the economic revival. They also assumed that it could efficiently improve the employment level leading into full employment operations. However, their assumptions were partly true since the move boosted the employment and economic performance of the nation. But at the same time it caused severe inflation which made life so unbearable. The ravaging inflation made central bank to abruptly implement a tight monetary policy in 1979. Although the policy was effective in reducing the growth of money supply in the economy, it triggered a sharp recession in early 1980s. Nevertheless, there was a successive financial modernization after 1980, which aimed at reforming the entire banking industry. The early 1990s marked the longest economic expansion in the banking history (Block, 1977). Fed was affirmed to operate as the nation’s central bank hence boosting the economic liquidity of various banks in the economy. The consumer credit level was also raised during this period.
The research was a theoretical overview study that answered the research questions as well as objectives through a review of various literature sources. The research used rich information from a number of literatures touching specifically on the role of the American banks to the economy especially on the control and regulation of money supply and consumer credit. Sources like books, publications, journals and relevant literature review from the internet sources were used in the research.
The proposal has as well made use of qualitative research approach, in an effort to contextualize the study by getting the researcher deeper into the investigatory scenario and the research subjects. Objectives are formulated, data collected and is expected that the results obtained was indeed be subjective. The specification of the research made it possible for the researcher to interrogate various concepts that were previous unthought-of and as such bring to light a whole new perceptive of the study.
Sampling procedure and population selections
The research identified some of the important policy changes that Federal Reserve System made in order to regulate money supply and consumer credit in the economy. It examined policy changes since Fed inception in 1913 and their impacts in the overall economic growth in the US. It is the assumption of the study that the identified policies and practices are not only in a better position but also capable of giving relevant and necessary information on the banking role in the economy.
Methods used in data collection
The data collected is of great importance as it assists in addressing the research objectives as well as answering the research questions in the most comprehensive and appropriate manner. The research uses a thorough scrutiny of both the primary and the secondary sources of data. AnIn-depth investigation of the banking sector was of paramount importance in collection of data necessary for making a clear and informed conclusion.
Physical data collection from the identified target population was done. The stakeholders in the banking sector were identified as respondent and were required to fill the formulated questionnaires and to give their views on the role of banking sector to the overall economy. Among the questions which dominated the questionnaires included the role of banks in the economy, money supply and consumer credit.Deliberate efforts were be made to distribute the questionnaires to all respondents on the same day and collect them later on the same date. This made my work easier as standardized information was obtained from the data collected. Random sampling procedure was used to select the sample size.
Materials and information from the internet, library as well as other related reports were used to collect relevant data concerning money supply and consumer credit. In addition, information from previous studies, journals, books and publications were used to support the study.
Research findings and results
From the research findings, it’s appropriate to say that the banking sector plays a significant role in the economy. Led by the Federal Reserve System responsible for control and regulation of money supply and consumer credit, the bank played a huge role in the running of the economy. During the period prior to 1970s, there was an expansionary monetary policy which lowered interest rates thus boosting consumer credit. This was made in the assumption that it would boost the economic growth and also improve the employment level to a full capacity. It was however possible in short run, but in the long run the policy worked against this as it welcomed a souring inflation into the economy. There was a ravaged inflation towards the end of 1970s decade, a condition which made the Federal Reserve implement a new policy. Responding to this condition, the government abruptly implemented a tight monetary policy with an aim of recalling back the over supplied money into the Federal Reserve. This move was intended to slow down the rising rate of inflation in the economy. It was however not effective due to the economic recession of 1980 which further worsened the condition. There was however a successive financial modernization after 1980, which was aimed at reforming the banking industry entirely. And the early 1990s marked the longest economic expansion in the banking history. Fed was affirmed to operate as the nation’s central bank and boosted the economic liquidity of various banks in the economy. The consumer credit level was also raised during this period.
The establishment of the Federal Reserve System was a positive step towards ensuring efficient supervision and regulations in the banking sector. The move was also suitable as it gave the Federal Reserve the responsibility of regulation money supply and consumer credit in the economy. Fed worked well in protecting the American consumers from the excessive financial exploitations by the privately owned financial institutions. It ensured that all commercial banks and investment banks met the required banking standards before initiating their services to the public. The change of policies and practices to accommodate modern banking system in the late 1980s greatly improved the liquidity preferences in the economy. Through the new banking policies American consumers were able to efficiently acquire increased credit facilities which boosted the economic growth.