The Fed Explained (2024)

FAQs

What is the Fed explained? ›

The U.S. central banking system—the Federal Reserve, or the Fed—is the most powerful economic institution in the United States, and perhaps the world. Its core responsibilities include setting interest rates, managing the money supply, and regulating financial markets.

The Board of Governors—located in Washington, D.C.—is the governing body of the Federal Reserve System. is an agency of the federal government that reports to and is directly accountable to Congress.

As the central bank of the US, the Fed has the power to either pump cash into the banking system (by buying Treasury securities) or take cash out of the system (by selling them). This concept is known as “open market operations.”

A particularly severe panic in 1907 resulted in bank runs that wreaked havoc on the fragile banking system and ultimately led Congress in 1913 to write the Federal Reserve Act. The Federal Reserve System was initially created to address these banking panics.

The Federal Reserve works to promote a strong U.S. economy. Specifically, Congress has assigned the Fed to conduct the nation's monetary policy to support the goals of maximum employment and stable prices. Those two goals are often referred to as the Fed's "dual mandate."

The Federal Reserve, the country's central bank, is self-funded: It mostly gets its operations covered via interest from securities that it owns as part of the Fed's open market operations (OMO).

Federal Reserve Banks' stock is owned by banks, never by individuals. Federal law requires national banks to be members of the Federal Reserve System and to own a specified amount of the stock of the Reserve Bank in the Federal Reserve district where they are located.

There are two kinds of national debt: intragovernmental and public. Intragovernmental is debt held by the Federal Reserve and Social Security and other government agencies. Public debt is held by the public: individual investors, institutions, foreign governments.

The Federal Open Markets Committee sets the federal funds rate—also known as the federal funds target rate or the fed funds rate—to guide overnight lending among U.S. banks. It's set as a range between an upper and lower limit.

As the Federal Reserve conducts monetary policy, it influences employment and inflation primarily through using its policy tools to affect overall financial conditions—including the availability and cost of credit in the economy.

Who controls the money in the US? ›

The Federal Reserve System manages the money supply in three ways: Reserve ratios. Banks are required to maintain a certain proportion of their deposits as a "reserve" against potential withdrawals. By varying this amount, called the reserve ratio, the Fed controls the quantity of money in circulation.

Cons of the Federal Reserve

The Federal Reserve operates independently of the U.S. government, and its monetary policy decisions are not approved by Congress or the U.S. president. This independence helps the Fed operate free of political pressure, but it also limits the Fed's accountability.

Critics have questioned its effectiveness in managing inflation, regulating the banking system, and stabilizing the economy. Notable critics include Nobel laureate economist Milton Friedman and his fellow monetarist Anna Schwartz, who argued that the Fed's policies exacerbated the Great Depression.

With the Fed abolished, banks would be on their own; no more lender of last resort, or taxpayer bailouts. The inflation dragon would be slain.

Central banking prior to the Federal Reserve

The Federal Reserve System is the third central banking system in United States history. The First Bank of the United States (1791–1811) and the Second Bank of the United States (1817–1836) each had a 20-year charter.

The Federal Reserve System is composed of a board of seven members, 12 regional Federal Reserve Banks, and the Federal Open Market Committee. The Fed's main duties include conducting national monetary policy, supervising and regulating banks, maintaining financial stability, and providing banking services.

In the U.S., fiscal policy decisions are determined by Congress and the Administration; the Fed plays no role in determining fiscal policy. The U.S. Congress established maximum employment and price stability as the macroeconomic objectives for the Fed; they are referred to as the Fed's dual mandate.

The federal funds rate is the interest rate banks use when lending money to each other overnight. The Federal Open Market Committee decides it and affects short-term interest rates for everyone. On the other hand, the discount rate is what Federal Reserve Banks charge banks for short-term loans.

The Federal Reserve transfers its net earnings to the U.S. Treasury.