Insights & Stories

What is the “Fed"

Reading time: 8 Minutes

September 16th, 2022

federal reserve sign federal reserve sign

We've all heard about the "Fed." Headlines are constantly reading that the "Fed" raised rates, or dropped rates, or did some other "thing" that apparently the Fed does. But, just reading these articles it can be challenging to understand what the "Fed" (more formally known as the Federal Reserve System, or FRS) actually is and how it impacts our nation's economy. In this article, we've put together everything you need to know about the Fed, its five main functions and how it works to try to keep inflation under control.

What is the "Fed"?

Established by the Federal Reserve Act signed by President Woodrow Wilson on December 23, 1913, the FRS was a response to a series of financial panics – particularly the panic of 1907. This financial crisis was set off by a series of bad banking decisions in that year, leading to a general public distrust of the banking system. Simply put, the FRS is the central bank of the United States that provides a flexible, stable and safe monetary and financial system to the nation. The system continued to expand through the years as the Great Depression in the 1930s and the Great Recession during the 2000s – and it continues to evolve today.

The FRS has a board of governors known as the Federal Reserve Board (FRB) that consist of seven members nominated by the President and approved by the U.S. Senate. Each governor is able to serve for a maximum of 14 years. In addition, there are twelve regional Federal Reserve Banks located throughout the country, each with its own president, to regulate privately owned commercial banks.

How does it work?

The FRS holds five important functions in order to promote the effective operation of the United States economy and public interest.

  1. Conduct National Monetary Policy

One of the main duties of the FRS is to influence monetary and credit conditions in the U.S. economy to ensure and promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy. Traditionally, the Fed uses three main tools to conduct national monetary policy: reserve requirements, open market operations and the discount rate. Throughout the years, the Fed began paying interest on reserve balances held at Reserve Banks and including overnight reverse repurchase agreements to support the level of the federal funds rate.

  1. Maintain Financial Stability

Another of the main jobs of the Federal Reserve System is to promote the stability of the financial system and actively manage risks through careful and active monitoring in the U.S. and abroad. The FRS works closely with agencies both at home and across the globe to ensure the system is supporting a healthy economy for the country's communities, businesses and individual homes.

In order for a financial system to be stable, its markets and institutions have to be resilient and be able to function even after an economic shock. Homes, businesses and communities should be able to have all the resources and products that they need to function well in the community. Some of these resources include business lines of credit, mortgages, student loans and other options for finance investment and large purchases; savings accounts, mutual funds, retirement accounts and brokerage services that help individuals manage assets; and an effective U.S. payment and settlement system.

  1. Supervise Individual Financial Institutions

It is the FRS' responsibility to supervise and regulate individual financial institutions and monitor how they affect the financial system as a whole. The Federal Reserve accomplishes this by working hand in hand with other federal and state authorities to make sure that these institutions are safely managing operations and providing fair services to consumers.

The Fed also works together with bank examiners who provide information on trends in the financial industry. The examiners will perform an on-site review of the bank's performance and whether it is in compliance with regulations and operating in a safe manner.

Supervision of these institutions vary according to their size and complexity. The Fed will establish rules within which the institutions operate, such as specific reg­ulations and guidelines governing the formation, operations, activities, and acquisitions of financial institutions. The Federal Reserve also offers many resources to assist banking organizations and the public understand these rules and related expectations.

  1. Provides Banking Services

Much like how banks might provide services to consumers, the Fed provides certain services to banks, credit unions and other financial institutions. Some of these services might include collecting checks, electronically transferring funds, distributing and receiving cash and coin. Additionally, the Federal Reserve plays the role of the fiscal agent for the U.S. Treasury. They assist financial institutions in understanding policies governing reserve balances, term deposits and discount window lending programs and meet reporting requirements.

  1. Protect Consumers and Promote Community Development

The FRS promotes consumer protection and community development through consumer-focused supervision and examination. The FRS also conducts research and analysis of emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations.

How does the Fed handle inflation?

As our nation is currently experiencing record-high inflation rates, the Federal Reserve is working hard to keep prices stable and prevent them from rising or falling too quickly. In 2012, the Fed began explicitly stating the 2 percent inflation rate as most consistent over the longer run with its mandate for stable prices. In 2020, the policymakers changed the goal to inflation that averages 2 percent over time – in contrast to aiming for 2 percent at any time.

Inflation happens when spending on goods and services outpaces production. Supply has been drastically impacted by COVID-19, causing the cost of producing goods and services to skyrocket and consumers spending cash faster than producers can increase production.

The FRS controls inflation by influencing interest rates. When inflation is too high, the Federal Reserve will raise interest rates to slow the economy and bring inflation down. And, when inflation is too low, the Federal Reserve will typically lower interest rates to stimulate the economy and move inflation higher.

If you're interested in learning more about the Fed, visit these links below:

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