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- The Federal Reserve, or “the Fed,” is the central banking system of the US.
- The purpose of the Federal Reserve is to regulate banks, manage the country’s money supply, and implement monetary policy.
- The Federal Reserve System consists of three entities: The Federal Reserve Board of Governors, 12 regional banks, and the Federal Open Market Committee (FOMC).
There’s a bank that you use to deposit your checks and make purchases — and then there’s the bank.
The Federal Reserve, or “the Fed,” is the central banking system of the US, and just about everything it carries out influences your financial decisions and opportunities more than you may realize.
An independent federal agency, the Fed was established in 1913 in response to a series of bank failures and stock market panics that were causing growing unease with the US’ largely unregulated financial system.
By creating a central bank, the government hoped to provide a stable yet flexible authority that could manage the nation’s monetary policy, regulate its financial institutions, and instill confidence in the US economy.
Here’s what you need to know about the Fed, and how it affects you and your money.
What does the Federal Reserve do?
The Fed’s mission is the same now as it was when it was established: To serve the public interest and provide the country with a safe and stable financial system. The Federal Reserve’s main responsibilities include:
- Managing the nation’s money and money supply
- Maintaining banking payment and transaction systems
- Creating and monitoring rules for banks and financial systems
- Ensuring that banks are offering quality products and following consumer protection laws
- Setting certain key interest rates
By overseeing the nation’s banks and influencing interest rates, the Fed impacts the economy and Americans’ financial lives.
While it doesn’t interact directly with individuals, it ensures they can deposit a check, use a debit card, and transfer funds safely and consistently. The policies the Fed sets ultimately affect how easy or hard it is to qualify for a mortgage, the interest you’ll pay on a loan, and how much money that savings account or CD will earn you.
How is the Federal Reserve structured?
Headquartered in Washington DC, the Federal Reserve comprises three major entities: the board of governors, the 12 regional regional reserve banks, and the Federal Open Market Committee (FOMC).
The Federal Reserve Board of Governors
The Federal Reserve Board of Governors is the main governing body of the entire Federal Reserve System. The Board is made up of seven members where each is nominated by the President and confirmed by the Senate.
As written in the Fed’s founding statute, the Board of Governors must consist of a “fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country.”
Board members serve a maximum term of 14 years, with new members being circulated in regularly.
The Board must appear before Congress at least twice per year to report on “the efforts, activities, objectives and plans of the Board and the Federal Open Market Committee.” Board staff regularly meets with congressional staff to brief them on financial issues and the Federal Reserve’s intended remedy or course of action.
The Board’s other responsibilities include general guidance for the system, serving on the Federal Open Market Committee, and overseeing the 12 Reserve Banks.
The 12 Federal Reserve Banks
Compared to those of other nations, the US central bank is somewhat de-centralized.
The Federal Reserve has 12 regional offices, known officially as Federal Reserve Banks. Each office, which has its own Board of Directors and President, is responsible for a district of several states surrounding it:
Shayanne Gal/Business Insider
Reserve Banks basically serve as branches of the entire Federal Reserve system. Originally, they were intended to operate independently, setting their own policies and interest rates. But as the US economy grew more complex and geographically integrated, new legislation in the 1930s and in 1980 made them more coordinated with each other and with their federal parent.
Today, each Federal Reserve Bank is responsible for implementing the decisions of the Fed’s Board of Governors and enforcing its rules on a regional level. It’s the district Federal Reserve Bank that directly oversees individual, local banks — granting their charters and inspecting their operations.
Some of the day-to-day services the Reserve Banks provide include:
- Loaning money to banks
- Maintaining US Treasury bank accounts
- Processing and clearing checks
- Releasing new coins and paper bills to banks
- Taking in defaced, ripped, or counterfeit currency
While the regional banks don’t set monetary policy, they do provide economic research to the national Fed — data and analysis that play a key role in the decisions made by the central bank’s all-important Federal Open Market Committee.
The Federal Open Market Committee
The third and arguably most influential arm of the Federal Reserve is the Federal Open Market Committee (FOMC). Added to the Fed in the 1930s, this policy-making group is made up of 12 voting members, including all seven Fed Governors, the President of the Federal Reserve Bank of New York, and four of the 11 other Reserve Bank Presidents.
The group meets at least eight times per year and is responsible for reviewing the country’s economic conditions, conducting risk assessments on economic growth, and managing the federal funds rate.
When the alert flashes on your phone or you hear a newscaster say, “The Fed cut interest rates today,” it’s a move by the FOMC they’re referring to.
How does the Federal Reserve influence the economy?
The Fed has other tools in its arsenal to encourage banks to ramp up or rein in their financing activities. Among them:
- Modifying the reserve requirement. As mentioned, banks are responsible for keeping a percentage of their total deposits in reserves. If the Federal Reserve wanted to expand the money supply, it can simply lower this requirement, so banks have more money to lend. If it wants to tighten the money supply, it raises the requirement.
- Setting the “discount rate.” Instead of borrowing from one another, financial institutions can also borrow money directly from one of the regional Federal Reserve bank “windows.” The rate at these windows is often higher than the federal funds rate itself and serves as the cap for the market — no bank would want to pay more money when a lower rate is available. As a result, the Federal Reserve can encourage banks to borrow from one another and can effectively limit the amount of interest charged.
- Increasing the interest rates paid on bank reserves. The Fed can change the amount of interest it pays banks on their reserves. Banks will not loan money to one another for less than that amount, so this move by the Fed effectively sets a floor for market interest rates.
Constantly gauging the pace of the US economy, the Federal Reserve is able to help the country either slow down or speed up its investing and spending and keep inflation moderate.
What is the Fed tapering process?
In times of economic distress, the Federal Reserve may resort to a process known as quantitative easing (QE), in which it buys massive quantities of government bonds and mortgage-backed securities to increase the money supply, encourage lending, and lower interest rates in order to stimulate a lagging economy. Once the goals of that stimulus are met, the Fed may gradually begin to unwind the purchases and raise interest rates to allow the economy to restabilize. This process is known as tapering.
“Tapering is like slowly taking your foot off the accelerator,” says Gary Zimmerman, founder and CEO at MaxMyInterest. “Your speed starts to decrease but you’re still adding gas to the engine and moving forward.”
The Fed’s motivation for tapering is to slow down the economic stimulus it started to boost a sagging economy once the goals of the stimulus program have been met. The Fed declared those goals, “maximum employment” and “price stability,” met in November, 2021.
Ultimately, quantitative easing cannot continue forever since it can lead to high inflation, have a negative impact on savings and pensions, and devalue the dollar. Tapering is a controlled way to slowly end QE while managing the continued economic recovery.
Tapering, like quantitative easing, involves manipulation of the economy. Investors can interpret a sped-up taper as a sign interest rates will be raised soon, resulting in a panic as was seen when Fed officials indicated that they would begin tapering the asset-purchase program put in place amid the global financial crisis. On the other hand, tapering too slowly, or failing to raise interest rates at the right time, can fuel inflation.
Who oversees the Federal Reserve?
When created in 1913, the Federal Reserve was intended to be an independent government organization that can operate without Congressional oversight or funding — or, in fact, management by any authority in the executive branch.
While the Board of Governors does report on its activities to Congress at least twice per year, it is not overseen or controlled by anyone. In fact, the Federal Reserve doesn’t even receive any money or appropriation from Congress. It’s financed mainly by the interest on the US Treasury securities it owns, along with the interest it charges on its bank loans, and fees for maintaining various interbank transactional services.
That is not to say that the Federal Reserve is not responsible to anyone. First and foremost, it is responsible to the American people and as such operates in a very transparent fashion — even going so far as to publish its meeting minutes and public policy briefs on its website.
The Fed’s key objective — to ensure an even money supply, and through that, a healthy economy — has been put to the test several times throughout its history. The Federal Reserve has been instrumental in helping the country navigate through the Great Depression, the 2007- 2009 Great Recession, and the COVID-19 pandemic.
The central bank can only do so much to alter the natural up-and-down trends of the business cycle. But, by modifying the federal funds rate, increasing the money supply, and lowering financing costs to banks — and ultimately, to their clients, businesses, and consumers — the Federal Reserve can try to prevent severe recessions or lessen the blow of other economic crises.
