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The Federal Reserve traces its origin to 23 December 1913. It is the central banking system in the United States of America created by the Federal Reserve Act. It has evolved and expanded over time due to economic changes such as the Great Depression. Currently, the Federal Reserve performs numerous functions including maintenance of the stability of the financial system, regulation of banking institutions, and control of the country’s monetary policy. Its Board of Governors is composed of members appointed by the president and approved by the Senate as provided in the constitution. The Federal System works as an independent body from the government so as to ensure accountability and transparency are maintained.
The current chairman to the Federal Reserve Board is Dr. Ben S. Bernanke. He has served the board for five years and ten months so far. According to Strawser & Ryan (2008) governors to the Board include Dr. Janet L. Yellen who is the vice-chairperson, Ms. Elizabeth Duke, Mr. Daniel K. Tarrulo, and Ms. Sarah Bloom Raskin.
The governors have similar experiences having served in different capacities in matters relating to economics and finance. They have worked in different institutions undertaking similar careers related to economics and financial management. In addition, all the governors have worked in management positions and as financial advisors relating to various economic issues. On the other hand, they differ in the courses they pursued. Some governors studied Economics at the university level while some studied Law. Other governors have had a teaching experience as professors and associate professors unlike others who have not taught at institutions of higher learning. They also differ in the level of education as some have pursued their courses up to the Ph. D level while most of them hold Masters Degrees in their respective fields.
The steepness of the yield curve could be used as a predictor of recessions for two reasons. Firstly, the current monetary policy influences the spread of the yield curve and the real economic activities over the coming years. This means that if short rates are expected to rise, the yield curve would flatten; thus, an indicator of slowed economic growth in the future. A rise in the short term rates means that borrowers would not be willing to take up loans and advance their investments while lenders would be willing to give out loans with the expectation that they would get a higher return of interest in the short term. Estrella & Mishkin (1996) assert that reduced investments are shown by the flattening of the yield curve and hence a real indicator of a looming economic recession.
The steepness of the yield curve also forms the basis of expectations of future inflation and interest rates. This helps in the prediction of the future economic activity. Real interest rates would be used to predict the future economic conditions. In cases where there is a rise in real interest rates, the economic activities would decline as indicated by the yield curve. This is because of an expected decrease of return on investments. The rise in inflation would be an indicator of reduced economic activities in the future because of increased borrowing costs. This means the economy is headed towards a recession.
The economy is likely to be headed for a recession if the yield curve is inverted. This gives a higher percentage of the expected recession. An inverted yield curve means that the returns on investments would have declined considerably. This would discourage investors from further investments thus reducing the overall economic activities. This is supported by the increased interest rates in the economy. Borrowers would not be willing to take loans for the advancement of their investments hance slowing down the overall economic activities. The slowed economic activities indicates a higher percentage of the expected recession in the economy.
The yield curve is currently spread between a ten year Treasury note and a three month Treasury bill. This means that the economic activities are going to increase. The increment in the economic activities would be supported by both the availability of short -term and long- term funds. Investors would be wiling to borrow more short-term funds by issuing Treasury bills with a shorter maturity period in order to avert high interest rates. According to Estrella & Mishkin (1996) investors could borrow long-term funds with a longer maturity period because there would be adequate time to settle all the loans. They would be more optimistic about the interest rates. This would be a significant boost to the economy as activities increase.
Money multiplier refers to a ratio of commercial banks money to the central bank’s money as agreed under the fractional banking system. It determines the total amount of money that could be created by commercial banks in relation to the central bank’s given unit of money. Carbaugh (2010) intimates that money multiplier determines the creation of money by commercial banks in relation to a given percentage of the customers’ reserves. This is under the regulation of the central bank.
Banks create money through the money multiplier model. Initially, banks receive money from their customers. This money is in te form of deposits as customers look forward to ensuring that they save some part of their money. The banks would then calculate the reserves that ar supposed to remain in the bank according to the percentage put in place by the central bank. This means they would keep the money in customers accounts as savings. Carbaugh (2010) asserts that the bank would then take the remaining amount of the total money deposited and advance it to other customers in the form of loans. In addition, the bank would charge a given interest on the loans which is payable according to the set period. The bank gains from the payment of the principal and interest rates. The more the deposits from customers, the more the bank creates credit opportunities. According to Carbaugh (2010), the cycle of calculation of reserves and lending out excess reserves continues as the bank multiplies the initial deposited amounts. An individual deposit is likely to generate five times the initial amount.
The money multiplier model is the main method by which banks create money. It involves the use of customer deposits to create credit opportunities for borrowers. This earns an excess amount in terms of the principal and the interest charged. It is regulated by the central bank.
In conclusion, the Federal Reserve refers to central banking system in the United States of America. It controls the countries monetary policy and regulates other banks. The current chairperson of the Federal Reserve is Dr. Ben S. Bernanke. The governors to the board have similar experiences relating to working in various positions, in various financial institutions. In addition, they differ in their fields of study as some have pursued Economics while others Bachelor degrees in Law. The yield curve steepness is an indicator of a recession because it could be used in the prediction of future interest rates and inflation. The steepness also predicts a recession because the current monetary policy influences the spread and hence an indication of economic activities. A rise in the short term interests implies that there would be reduced economic activities, which would lead, to a recession.