The best remedy for combating inflation or recession is to decrease or increase the aggregate spending. Monetary policy can help in decreasing or increasing the Compressing of demand (Vines and Gilbert 2004). The Monetary policy work by scheming the cost of availability of credit. During inflation, the central bank can raise the cost of borrowing & reduce the credit creating capacity of the commercial banks (Mehta 2002 p. 87). This will make borrowing more costly than before & thereby the demand for funds will be reduce. Similarly, with a reduction in their credit creation capacity, the bank will be more cautious in their leading policies. Federal Reserve Federal Reserve System is the name of the central banking system of United States, which introduced by a 1913 act of Congress. The Federal Reserve Act sometimes called the Glass-Owens Bill (Stephenson, 1934, p. 1179). The legislation provided for a stable central banking system after the system set up by the National Bank Act of 1863. Economic Recession Definition Many specialized and experts around the world believe that a true economic recession can only be established if GDP (Gross Domestic Product) growth is negative for a period of two or more successive quarters. It is really more common than realize for countries around the world to practice mild economic recessions. Recession (or contraction) is a natural result of the economic cycle and will adjust for increasing and decreasing prices of goods and services and consumer spending. Three ways of the Federal Reserve can change the money supply The Fed influences the money supply with three tools that work on the amount of reserves in the following ways (Kroon 2007, p. 133): First, Federal Reserve sets the "reserve requirement" for all commercial banks (Klein1986, p.258). The reserve requirement is the amount of money a commercial bank must hold in central bank (Federal Reserve) to reserve relative to all the money it has lent out. Thus, the Fed can decrease the money supply by increasing the required amount of reserve, which decrease the money circulation of the system (Case and Fair 2008, p.533), and when the Fed want to increase the money supply by decreasing the reserve requirements. Secondly, ?[a]nother key responsibility of the Fed is controlling the money supply. By buying and selling US Treasury securities, the Fed targets and largely controls? (Martin and Epstein 2003 p.6). It is the second way of the Fed controls the money supply is buying and selling of Treasury bills, bonds and notes (Hubbard and O'Brien 2008 p.450). When the Fed sells a T-Bill, it's taking money out of the system and replacing it with a security, which isn't counted in money supply ? and vice versa when the Fed buys back bills and notes. Finally, the Fed moderates the money supply through raising or lowering interest rates. The Fed sets the required reserved rate, the interest rate of money borrowing, and the discount rate, which is the rate the Fed charges banks to borrow from it. The discount rate is the interest rate the Fed charges local banks to borrow money from the Federal Reserve System (Bateman 2001 p. 84). Banks increase & decrease in these rates by adjusting their loaning and borrow rates accordingly. Increasing rates tend to fall money supply by discouraging use of money for spending. The increase in money spends the falling rates. If the Federal Reserve is going to adjust all of these tools during an economic recession the change will be makes are follows: 1. In recession the Fed will reduce the minimum reserve of cash which bears more or less a definite relationship to the volume of commercial banks deposit in Federal Reserve (central bank). For this reason the commercial banks are produce more money supply in market with a low interest rate & the money circulation will be rise in market. 2. The Fed controls the money supply is buying of Treasury bills and notes. When the Fed buys a T-Bill at market, it's give money out of the system and replacing it with a security. 3. In recession the Fed will decreasing the interest rate. For that peoples take money from bank what they deposited in commercial bank. As a result the money circulation will be increase in market. If the Federal Reserve is going to adjust all of these tools during an economy growing too quickly the change will be makes are follows: 1. In inflation the Fed will the Fed will increase the minimum reserve of cash which bears more or less a definite relationship to the volume of commercial banks deposit in Federal Reserve (central bank). For this reason the commercial banks are reduce money supply in market with a higher interest rate & the money circulation will be decrease in market (Wyss 2000 p. 31). 2. The Fed controls the money supply is selling of Treasury bills and notes. When the Fed selling a T-Bill at market, it's taking money out of the system and replacing it with a security. That is the money circulation in market will decrease. 3. In inflation the Fed will increasing the interest rate. For that peoples deposit money in commercial bank. As a result the money circulation decreases in market.
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