Efficiency of the Federal Reserve under Globalization and Presence of Electronic Transactions

ABSTRACT The Federal Reserve--the central bank of the United States--often is cited as the regulator of our economy. This economy is the largest in the world, and, by virtue of the interdependence of other global economies through the foreign exchange market and other capital markets, the Federal Reserve exerts an enormous influence for our financial architecture. All of this influence stems from its power to 'create' and 'destroy' money, and, by that process, it affects inflation, interest rates, and rates of foreign exchange world-wide. This work explains in depth how these come into being and shows the inter-link via monetary base, money supply, and exchange rates as they relate to stock in money supply. The first section delineates the change in money supply in the traditional economic framework, and in the second section, the relationship between money and exchange rate is sketched out in both the traditional and in the new age of globalization. Finally we question the adequacy of the inter-connectedness in terms of efficacy and immediacy of effectiveness when the electronic component of the money in circulation is factored in. JEL Classification: E58 and F37 Keywords: Federal Reserve; Electronic money supply; Globalization I. INTRODUCTION The Federal Reserve (the Fed, in shorthand) is the monetary policy arm for the U.S. economy. By its almost exclusive power to "create" and "destroy" money stock, it can regulate the flow of money supply for the economy, and, by this regulative flow of the money supply, it can moderate and/or control major economic variables in the economy. These major variables are interest rates, inflation rates, and exchange rates. Money traditionally means coins and currencies well as checks and check-type instruments the consumers and business houses have been using. However, The Federal Reserve Bank of Chicago recently notes, "in recent years, however, consumers seem to be changing their minds. Cash and checks are still widely used. Currency is used for the vast majority of payments, mainly for smaller purchases, and checks are the payment choice for about 10 percent of transactions each year, but the percentage of transactions done electronically is growing dramatically. The important role of electronic payments can be seen by looking at the value of payment transactions. Electronic payments account for more than 90 percent of the dollar value of transactions. This growth is made possible by electronic payment networks, which move funds in and out of accounts using electronic messages. Electronic payment systems range from the now-familiar automated teller machines (ATM) to Internet bill payments. This essay discusses the different types of electronic payment systems and looks at the future of electronic money." This phenomenon needs a close-up look at the money flow and its control on the economy or economies. Various scholars (Boorman and Havrilesky (1973), de Leeuw (1965), Meigs (1962), Bernanke and Kuttner (2005), Bullard and Waller (2004), Demiralp and Jorda (2004), Fand (2004), and so on) have made early attempts to explain the controlling mechanism of the Fed and have given guidance as to how to construct a framework for analytical discussion on the Federal Reserve's tools, techniques, and efficacy of policy decision. In the next section (Section II) we present the increase or decrease of money supply effected by this monetary authority in the traditional structure of analysis, and then we examine the efficacy of the controlling and regulating power of the Fed when we factor in velocity of circulation of money in the electronic transaction conduits. In Section III, we bring out the relationship amongst interest rates, inflation rates, and exchange rates without and with the reality of electronic funds transfer for the United States. In Section IV, we conclude with some observations. II. MONETARY STRUCTURE For any modern economy, and certainly for the United States in the traditional framework, the money supply is anchored in its monetary base (MB, also known as high power money). …