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The Role of the American Federal Reserve System

In addition to its many other responsibilities, the Board of Governors acts as "the creator and controller of the money supply" (Mayer, 1996, p. 400). Congress defined its role in 1977 as to "pursue maximum employment, stable prices and moderate long-term interest rates" (Yellen, 1996, p. 43). The most important component of the money supply is M-1 (currency in circulation and demand deposits).

Monetary Policy. Monetary policy is concerned with the size and rate of growth or contraction of the money supply and with the financial stability of the nation as opposed to fiscal policy which attempts to regulate the economy through government spending and tax policies. According to Yeller (1996), "monetary policy is needed, and has succeeded, in smoothing the ups and downs of the business cycle" (p. 40). This job of fine-turning the money supply is entrusted to the Fed. According to monetarists such as Milton Friedman, the key to economic growth was a stable, growing money supply, but neo-Keynesians such as the late Nicholas Kalder, believe that demand-determined variables were more important causes of the level of economic activity with money largely playing a passive or neutral function (Humphrey, 1993, pp. 144-154). The Fed has leaned toward the view of the monetarists and plays an active role in controlling the money supply.

3. Reserve requirements. Congress first gave the Fed power to determine t


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