Are current open market operations what the founders of the Federal Reserve System intended?
No. It was expected that in monetizing eligible short term commercial paper, the Federal Reserve would provide sufficient liquidity to sound banks in periods of need (or restrain excessive credit expansion). While the Federal Reserve was expected to exert supervisory powers, it was expected that the money supply and interest rates, would be fully responsive to business conditions. Thus the discount rate, rather than open market operations was regarded as the Federal Reserve s most important tool. 98. Why was the discount rate regarded as an important regulatory tool? Because under the original Federal Reserve arrangement, no specific limits were placed on the amount of money the system could create. After all, if the banks had eligible paper to rediscount, then the regional bank would automatically create reserves. This raised the possibility of infinite money creation provided the banks lending rates and the system s charges were in a fixed favorable relation. But if the system could
