What is the Federal Reserve? A guide to the world’s most powerful central bank

The banks’ bank. The lender of last resort. The orchestrator of the U.S. economy. These words are often used to describe the central bank of the U.S., officially known as the Federal Reserve System.

 

Investors and economists alike obsess over every word and sentence that comes out of the Fed, whether it’s public speeches from Fed officials or statements issued after meetings by its policymaking arm, the Federal Open Market Committee (FOMC).

 

What is the Federal Reserve?

 

The Federal Reserve, frequently dubbed “the Fed” for short, is the central bank of the U.S. Whereas fiscal lawmaking is left up to the three branches of government, the Fed sets monetary policy, mainly by adjusting interest rates, the money supply and bank regulations to foster economic stability.

 

Other countries, such as Canada, India, the United Kingdom and Japan, have their own iterations of the Fed. The European Central Bank sets policy for the European Union.

 

After a panic stoked a lack of trust and confidence in the banks, Congress created the current version of the Fed (there have been two others) in 1913, tasking it with maintaining “a safer, more flexible and more stable monetary and financial system.”

 

What Does the Federal Reserve System Do?

The Federal Reserve System is designed to regulate banks and financial institutions and to maintain the stability of the country’s financial system.

 

What Power Does the President Have Over the Federal Reserve?

Generally, the president influences the Fed through appointments only. The president nominates the Federal Reserve Chair and the seven members of the Board of Governors. The Senate confirms these appointments, and they cannot easily be removed.

 

What Would Happen If the Federal Reserve Didn’t Exist?

Before the Federal Reserve existed, the financial system was in chaos. Without it, there would be no lenders of last resort and no governance over interest rates or money supply.

 

How Does the Fed Set Interest Rates?

The Federal Reserve sets a rate range using three figures to adjust its rate range. The rate for its Overnight Reverse Repurchase (ON RREP) Agreement Facility sets the floor for the rate range. The Fed’s discount rate, or the rate it charges banks for overnight loans, sets the top number for the range. The Fed uses its Interest on Reserve Balances (IORB) rate in conjunction with ON RREP to keep the effective federal funds rate in its target range. Open Market Operations are used to keep enough money in reserve so that the Fed’s rates implement monetary policy.

 

The Bottom Line

The Federal Reserve System is the central banking system of the United States. The Fed uses the system and the tools it has to set interest rates and regulate the money supply to accomplish its dual mandate of price stability and maximum employment.

 

 Source: investopedia.com
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