The Federal Reserve, also often known as the Fed, is the central bank of the United States and is considered to be the most powerful financial institution in the world. The Federal Reserve was founded in 1913 to provide the US with a safe, flexible and stable monetary and financial system.
The purpose of a central bank is to create a financial institution that has privileged control over the production and distribution of money and credit for the nation or group of nations that it serves. Other examples of central banks include the Bank of England, the European Central Bank and the Swiss National Bank.
How the Federal Reserve works
The Federal Reserve is composed of 12 regional Federal Reserve Banks that are each responsible for a specific geographic area of the US. They are:
- Federal Reserve Bank of Boston
- Federal Reserve Bank of New York
- Federal Reserve Bank of Philadelphia
- Federal Reserve Bank of Cleveland
- Federal Reserve Bank of Richmond
- Federal Reserve Bank of Atlanta
- Federal Reserve Bank of Chicago
- Federal Reserve Bank of St. Louis
- Federal Reserve Bank of Minneapolis
- Federal Reserve Bank of Kansas City
- Federal Reserve Bank of Dallas
- Federal Reserve Bank of San Francisco
There are two main objectives of the Federal Reserve, to foster economic conditions that achieve stable prices and maximum sustainable employment. The duties of the Federal Reserve can be further categorized into four key areas:
The Federal Reserve was founded in response to the financial panic of 1907. Prior to its inception, the US was the only major financial power without a central bank.
- Conducting national monetary policy by influencing monetary and credit conditions in the US economy to ensure maximum employment, stable prices, and moderate long-term interest rates.
- Supervising and regulating banking institutions to ensure the safety of the US banking and financial system and to protect consumers’ credit rights.
- Maintaining financial system stability and containing systemic risk.
- Providing financial services, including a pivotal role in operating the national payments system, depository institutions, the US government, and foreign official institutions.
The organizational structure of the Federal Reserve consists of seven members on the Board of Governors. Each is nominated by the president and approved by the US Senate. A governor can only serve a maximum of 14 years on the board and their appointment is staggered by two years.
It is also dictated by law that appointments of governors must represent broad sectors of the US economy. In addition, each of the 12 Federal Reserve banks has its own president.
The Board of Governors are responsible for setting reserve requirements, the amount of money banks are required to hold to meet the demands of sudden withdrawals. They also set the discount rate, which is the interest rate the Federal Reserve charges on loans made to financial institutions and other commercial banks.
Central banks across the world play an important role in quantitative easing to expand private credit, lower interest rates and drive investment and commercial activity through FOMC decision making.
Quantitative easing is used to stimulate economies during periods of uncertainty such as recessions when credit is thin on the ground. An example of when quantitative easing was used was during and following the 2008 financial crisis.
Advantages of the Federal Reserve
The advantages of the Federal Reserve include:
During times of recession and periods of uncertainty, the Federal Reserve can help remove panic and provide help to financial institutions and their depositors in times of severe economic crisis.
Good risk containment system
The Federal Reserve regularly runs checks on the nation’s banks and financial institutions. It runs stress tests and reviews financial statements to make sure that the public is dealing with institutions that are in good financial standing, and are not overloaded with risk.
Disadvantages of the Federal Reserve
The disadvantages of the Federal Reserve include:
Not completely transparent
Many believe that private interest and lobby groups have significant influence over the Federal Reserve, allowing individuals to benefit rather than actions that benefit the whole society.