The Mysterious Fourth Tool of the Fed

David M. Gordon 
(University of Saint Francis, USA)

Abstract: The Federal Reserve System (FED) plays a vital role in our economy as our central bank. The purpose of this paper in part is to review the three traditional functions of the Federal Reserve System with regards to monetary policy. It is imperative that anyone with economic interests understand the importance of this role. Knowledge of how the Fed or any central bank conducts monetary policy has become even more important to grasp given the recent worldwide financial crisis as well as the still unfolding events in Europe. A brief history of the Fed is provided. Many economic participants are not aware of when the central bank first arrived in our economy. The roles and functions of the Fed are explored in the paper as well. This paper also offers an explanation of the traditional tools the Fed uses to conduct monetary policy. Open market operations are explained. The important role of the discount rate is discussed. The required reserve ratios are also explored. This author believes that the Fed has recently created a new tool. This tool is the payment of interest on demand deposit accounts at the Fed. This new tool is explained and its’ ramifications explored. The relative value of this tool is discussed in this paper as well. The functions of monetary policy are also expanded upon in this paper.

Key words: monetary policy; central bank; federal reserve functions

JEL code: E50