The Banking System

Federal Reserve

What Is the Federal Reserve?

The Federal Reserve is the central bank of the United States, responsible for ensuring stable monetary policies.
The Federal Reserve is the central bank of the United States; it serves as a banking institution for commercial banks to use and a way for the government to influence financial activity. A commercial bank is a private bank primarily concerned with maximizing its revenue by holding deposits and making loans and investments with a portion of those deposits. Congress created the Federal Reserve, which officially began when President Woodrow Wilson signed the Federal Reserve Act on December 23, 1913. The main goal of the Federal Reserve Act was to help the burgeoning country stabilize its currency. The Federal Reserve Act instituted many elements of policy, including the responsibilities of individual private banks, loans, the use of bonds, and other services. A bond is a financial instrument representing a loan made to a governmental or corporate body by some entity that requires repayment of the initial loan price plus interest on a fixed schedule.

The main purpose of the Federal Reserve is to regulate monetary policy. The three goals that the Federal Reserve aims to achieve are maximum sustainable employment, stable prices, and moderate long-term interest rates. The majority of work the Federal Reserve performs is deciding long-term interest rates and working to achieve the goal of price stability. Price stability is a state in which prices do not change much over time and there is little inflation or deflation. Through monetary policy, the Federal Reserve seeks to ensure that the country attains optimal rates of employment and economic growth; it does this by influencing the interest rate, which in turn affects households' purchasing habits, which affects the production of goods and services (which increases employment to react to increase in production). The Federal Reserve is also in charge of overseeing and regulating banks to achieve maximum stability, encouraging consumer confidence in commercial banking. These were important needs during the early 1900s, a financially volatile time, and are still important today.

Another central mission of the Federal Reserve is to function as a bank for depository institutions. A depository institution is a financial institution legally allowed to accept monetary deposits from customers. Banks, credit unions, and savings and loan associations are examples of financial institutions. Just as individuals' banks enable them to cash checks, the Federal Reserve performs a parallel function for the federal government and other large institutions. Most countries have national banking systems similar to the Federal Reserve, but these are most often simply called "central banks."

The Federal Reserve and Banking System

Note the relationship between the Federal Reserve, commercial banks, and private citizens, businesses, and smaller "main street" banks. The arrows show the flows of capital (money or other assets owned by a person or organization) in the system.

Structure of the Federal Reserve

The Federal Reserve is managed by the Board of Governors, of which the Chair is the head.
The Federal Reserve (the Fed) is the central bank of the United States. The Fed is run by its Board of Governors, which consists of seven members appointed by the President of the United States and confirmed by the U.S. Senate. One member of the Board of Governors is named Chair of the Federal Reserve Board of Governors. The Federal Reserve determines price stabilization and other monetary policies. These policies often reflect the philosophy of the Chair.

The seven members of the Board of Governors each serve staggered, nonrenewable 14-year terms. This system of cycling positions within the Federal Reserve is designed to minimize any political influence; the Fed was created to be independent in setting monetary policy.

There are 12 Federal Reserve Banks in the Federal Reserve System. The member banks are in Richmond, Boston, Dallas, Cleveland, Kansas City, Minneapolis, St. Louis, New York, Philadelphia, Atlanta, Chicago, and San Francisco. The Federal Reserve oversees these banks.

The Federal Open Market Committee is made up of the seven members of the Board of Governors as well as five voting members from the regional Federal Reserve Banks. The five voting members serve on a rotating basis. Four of the committee seats rotate between bank presidents, but the New York Reserve Bank president always has a seat. The committee is in charge of determining the vision and direction of monetary policy, including interest rates.