What Is the Federal Reserve?

September 11, 2019 · 2 minute read

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What Is the Federal Reserve?

If you listen to or read the news, you may have come across some version of the following story: “The Federal Reserve had increased (or decreased) its target rate.”

You’ve heard of the Federal Reserve and know that it plays an important role in the economy. You may even know that “the Fed” somehow controls interest rates.

But what may be less clear is how the decisions of the Fed affect regular Americans.

The Federal Reserve is the U.S. central bank system. As the country’s central bank, the Fed has a lot of big jobs. For example, the Fed implements policy and strategy in order to stabilize the economy and keep unemployment low.

These big-picture decisions made by the Fed may seem like they have little to do with your life, but such decisions could have an impact on your money and your employment. And if not you, the personal financial situations of people you love.

What does the Federal Reserve do? Why was the Federal Reserve created in the first place? Here’s more about the Federal Reserve, along with reasons it should be important to you.

Why Was the Federal Reserve Created?

When there was no central bank, the banking system was fraught with bank failures and “bank runs,” where depositors would rush to banks to withdrawal all of their money. To create a safer and more stable bank system, President Woodrow Wilson signed the Federal Reserve Act .

About now, you might be envisioning one big cartoon bank bursting with gold bars and plopped down in the center of Washington, D.C., but the Fed is actually an intricate system that consists of several different parts. These are the three bodies of the Fed:

The Federal Reserve Board of Governors

There are seven Federal Reserve board members that oversee the Federal Reserve System. This includes the chairman and vice chairman. As of 2019, the chairman is Jerome Powell. Before him, the chairman of the Federal Reserve was Janet Yellen.

The Board of Governors, which is made up of seven governors, is based in D.C. and reports to Congress. Board members are appointed by the U.S. president and serve staggered 14-year terms (so the entire board isn’t replaced in a single year). The chairman and vice chairman serve four-year terms and may be reappointed at the end of their term.

Federal Reserve Branches

There are 12 Federal Reserve bank branches in major cities throughout the country that act as the operating arms of the Federal Reserve.

You wouldn’t walk into a Federal Reserve bank and open up a checking account. Instead, Federal Reserve banks work with other institutions, such as banks and credit unions, and the U.S. Treasury. They provide services like holding deposits for banks, processing payments, and issuing and redeeming government securities.

The Federal Open Market Committee (FOMC)

What Does the Fed Do?

The Federal Reserve has several primary functions:

Setting Monetary Policy

One of the primary roles of the FOMC is to set monetary policy. With monetary policy, there are typically two primary goals: Maximum employment and stable inflation.

Often, we hear about monetary policy in terms of the setting of the federal funds rate. This is the rate at which banks charge each other on an overnight basis.

A bank might need to borrow money from another bank in order to meet the Fed’s minimum reserve requirement, or how much cash the bank has available in its reserves.

The federal funds rate as set by the FOMC may influence other interest rates. In this way, the federal funds rate can be used as a tool to encourage or restrict borrowing. For example, the Fed may attempt to fight inflation by raising the federal funds rate. Conversely, the Fed may lower that same rate in an attempt to ward off a recession.

But this isn’t the only monetary policy that the FOMC is engaged in. According to the Federal Reserve, its main tool for controlling the money supply is “open market operations,” which is the buying and selling of government securities, like treasury bills. They may do this in conjunction with a rate change or other strategies.

Regulating Banks

To ensure the safety and solvency of the nation’s banking and financial system, the Fed regulates banks and other financial services institutions. This is done not only for the protection of the consumer but to promote stability within the banking system.

The Board of Governors typically sets guidelines for member banks through policy regulation and supervision. The Reserve Banks then examine member banks to ensure that they comply with existing laws and regulations. Often, new guidelines are created because of legislation that has been passed through Congress.

Overseeing Payment Systems

The Fed provides financial services to the U.S. government, major financial institutions, and foreign official institutions. The Fed acts as the depository institution for the U.S. Treasury—essentially, the Treasury’s checking account.

The Fed also plays a major role in operating and overseeing the nation’s payment systems. In addition to making sure there is enough currency in circulation, the Fed clears millions of checks and processes electronic payments. Social Security checks and the payrolls of government institutions are processed by the Fed.

Limiting Risk

At the end of the day, the Federal Reserve wants to control risks to the economy and financial markets (such as the stock market) as best they can. They utilize a number of measures, including those discussed above, in order to best achieve this stability.

How Does the Federal Reserve Affect Me?

Although you might not always feel it, the Federal Reserve enacts policies and makes decisions that affect the lives of everyday Americans.

Although the Fed does not set rates like mortgage rates and credit card interest rates, those rates can shift as the Fed Funds rate does.

An increase or decrease in interest rates can affect consumers in plenty of ways. If overall rates increase, then it becomes more expensive to be a borrower. Variable interest rates may rise, and any new debt will be issued at higher rates.

The rates at which money is flowing freely throughout an economy may also have rippling impacts. For example, when rates are low and access to money is cheap, businesses may borrow money in order to invest in development or expand operations. If there is too much money in circulation, inflation may increase. This could cause the prices of everyday goods, like groceries, to increase as well.

One of the Fed’s goals is an economy with full employment. If they are not able to succeed using the tools at their disposal, people may lose jobs, and unemployment may increase. This could also have effects throughout the greater economy, such as decreased consumer spending and overall slowed economic growth.

The decisions of the Fed may seem elusive and far away, but those same decisions can have a big impact on the lives of everyday people. In the meantime, you could try SoFi Invest to do more with the money that you already have. SoFi Invest offers both active and automated investing accounts—so it’s up to you how hands-on you’d like to be with the investing process. No matter which account you choose, SoFi charges no trading fees and requires no account minimums.

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