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THE FEDERAL RESERVE HOARD OF THE UNITED STATES OF AMERICA,[1]

[2]

The Federal Reserve's power is derived from the Constitution of the United States (Article I, Section 8). The article states: “Congress shall have power ... to coin money (and) regulate the value thereof ...” The Federal Reserve Act of 1913 established the Federal Reserve to realize the following objectives:

■ Furnish an elastic currency that would respond to the economic needs of the nation.

■ Serve as a last resort to defend against any run on the banking system of the nation.

■ Establish a more effective and responsive system to supervise banks.

■ Improve the efficiency of the national payment mechanism.

The 1946 Employment Act established a number of national goals that must be achieved by the Federal Reserve. These goals were expanded in 1978, when Congress passed the Full Employment and Balanced Growth Act. Following are the expanded goals:

■ Full employment

■ Increased real income (net of inflation)

■ Balanced economic growth

■ Balanced federal budget

■ Growth in productivity

■ Improved balance of trade

■ Price stability

The act also required the Federal Reserve to report to Congress twice a year on its monetary policies as they related to the goals outlined in the 1978 Full Employment and Balanced Growth Act.

Function of the Federal Reserve

The three basic functions of the Federal Reserve are:

1. Implementation of monetary policy. This is done through the use of three primary control devices:

■ Setting the reserve requirements of the banks.

■ Setting the discount rate at which the Federal Reserve lends the member banks.

■ Setting the monetary growth or contraction through the activities of the Federal Open Market Committee (FOMC); monetary expansion or contraction is done through the purchase or selling, respectively, of government securities.

2. Providing payment services for the depositories. These services include loans, check collections, currency insurance, wire transfers, and account settlements.

3. Serving as a bank for the federal government:

■ Supervising and regulating banks.

■ Maintaining the U.S. federal government's checking account.

■ Selling and redeeming interest payments on U.S. government securities.

■ Establishing relations with foreign central banks and foreign exchange trading worldwide.

The Federal Reserve was created as a branch independent of the politics of governing. Its shares are owned by participating member banks in proportion to their size. U.S. monetary policy, which includes adjusting interest rates and money supply, is designed and implemented without any political interference from the president or Congress. In such a unique setup, the monetary policy would be implemented for the interest of the nation, and not to promote a certain political party, the military, the press, the judiciary, Congress, or the president. However, the president of the United States designs and presents to Congress for approval the fiscal policy of the government, which includes the federal budget, taxes, and government spending. The Federal Reserve's structure as an independent central bank is unique among the world's central banks. This adds to the power of the Federal Reserve to influence the U.S. economy and to bring real creditability to the U.S. dollar worldwide.

  • [1] Yahia Abdul-Rahman, LARIBA Bank, Islamic Banking, Foundation for a United and Prosperous Community (Published by the author, 1994).
  • [2] Based on Friedman, Essentials of Banking (see note 3).
 
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