The Federal Reserve System

Introduction

The Federal Reserve System is a central banking system in the United States that provides various financial services to banks, institutions, and individuals. Congress created it in 1913 with the Federal Reserve Act. The Federal Reserve System’s main job is to regulate the nation’s money supply, interest rates, and foreign exchange rates; it also governs bank activities such as lending, credit quality, and consumer protection.

What is the Federal Reserve System?

The Federal Reserve System is also known as The Federal Reserve or simply The Fed. The Federal Reserve System is the central bank of the United States, and it serves as both a lender of last resort to banks and a regulator of monetary policy.

The Fed was created in 1913 by an act of Congress called the Federal Reserve Act. The Act addresses several major problems with U.S. banking:

• Banks were often unstable due to their reliance on short-term loans from each other rather than on deposits from customers who could withdraw all their money at any time (known as “demand deposits”).
• Bank runs were typical when depositors suddenly lost confidence in their bank and rushed to withdraw all their money, which would cause banks to fail without help from other banks or central authorities like stockbrokers, insurance companies, or even governments.
• There was no official way for federal regulators and Congressmen to coordinate fiscal policies among different branches of government.

Marriner S. Eccles Federal Reserve Board Building in Washington, D.C.

The Board of Governors

The Board of Governors oversees the entire Federal Reserve System. Located in Washington, DC, but its members travel to regional banks for meetings and hearings several times yearly.

The Board comprises seven members appointed to 14-year terms by the President and confirmed by the Senate. Six governors are from regional banks, while one is from Washington DC as a “Class C” member (meaning they have no voting power). The Board of Governors has a chairman known as “the Fed Chair.” Someone has traditionally held that position with expertise in economics or finance.

The first chairman was Charles Sumner Hamlin, who served under President Woodrow Wilson from 1914 to 1916.

Charles Sumner Hamlin, first chairman of The Federal Reserve System

The Regional Banks

There are 12 regional banks: New York City (Headquarters), Boston, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St Louis, Minneapolis/St Paul, Kansas City, and Dallas/Fort Worth. Each regional bank is managed independently but has some standard functions:

• Supervising each bank’s activities.
• Reviewing new banking charters.
• Managing monetary policy for their region.
• Issuing currency.
• Discounting commercial paper and government securities issued by state agencies and municipalities within their district.
• Making loans available to depository institutions at their discretion if required during economic stress.

Keeping Inflation in Check

One of the Federal Reserve’s tasks is keeping inflation in check, which it does through the monetary policy it develops. Monetary policy refers to the tools and strategies used by central banks like the Federal Reserve System to influence economic conditions. The Fed relies on several tools to achieve its goals, including changing the interest rate target, altering reserve requirements for banks, expanding or contracting bank credit, and buying or selling government securities (government bonds).

The goal of monetary policy is to maintain price stability—that is, keep prices from rising too high (inflation) or falling too low (deflation). Inflation occurs when more dollars are chasing fewer goods and services in an economy; deflation occurs when fewer dollars are chasing more goods and services.

Economic Growth

The Federal Reserve System oversees the production and circulation of U.S. currency, which it does in cooperation with the U.S. Treasury Department. That gives the Fed a vital role in creating economic growth or slowing down when necessary. It can do this by changing the money supply, interest rates, and purchasing bonds owned by banks and other financial institutions.

The Fed’s job is to ensure that the amount of money flowing into the economy matches the number of goods and services produced at a healthy level. If too much money is in circulation, inflation rises, and prices go up: Your dollars won’t buy as much stuff; they will become less valuable because you have less purchasing power for products than before.

Maintaining stability of the economy

The Federal Reserve System can provide short-term loans at low-interest rates on short notice to cover shortfalls in cash reserves through its discount window, which is open to all banks. The discount window is unavailable to individuals or non-bank financial institutions like insurance companies. Banks can borrow from the Fed anytime, whether they need funds for current operations or want some extra cash in their vaults. The Federal Reserve System also plays an essential role in maintaining the financial system’s stability through its supervision of banks and other institutions. The Fed supervises banks and other institutions to ensure they are safe and sound and takes corrective action when necessary.

Conclusion

The Federal Reserve System is a crucial part of the economy. It helps ensure the country has a stable financial system and plays a vital role in creating economic growth or slowing down when necessary. The Fed also plays an essential role in maintaining the financial system’s stability through its supervision of banks and other institutions.

Brooks Kraft/Getty