What is the Federal Reserve and What Do They Do?

December 09, 2019

The Federal Reserve has been in the news a lot lately, as they have reversed course and have begun lowering interest rates.  The Fed is generally independent of politics but President Trump has recently been critical of Chairman Jay Powell, whom Trump appointed.  Most of us have heard of the Federal Reserve and know that the “Fed” has a role in setting interest rates, but many are unaware of what the Fed is and what it actually does.

The Federal Reserve, or the Fed, is the central bank of the United States.  It was created by Congress in response to a series of financial panics.  The Fed’s mandate is to provide the nation with a safer, more flexible and stable financial system.  The Fed is headquartered in Washington, DC and consists of a network of twelve regional Federal Reserve banks.  The Fed is managed by a Board of Governors.

The Board of Governors has seven members, appointed by the president and confirmed by the Senate.  They serve 14 year terms and the terms are staggered so one Governor’s term expires each even-numbered year.  A chairman and vice chairman lead the board, each serving a four year term in that capacity.  The chair and vice chair positions on the Board of Governors also requires presidential appointment and Senate confirmation.  The current chair of the Fed is Jerome Powell. He was sworn in on February 5, 2018 after being appointed by President Trump in November 2017.

The Federal Reserve System is divided into 12 districts.  The districts are headquartered in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.  We are located in the Chicago district.

The Fed is tasked with conducting the nation’s monetary policies, specifically pursuing full employment and maintaining stable prices and moderate long-term interest rates.  They also supervise and regulate banking institutions and maintain the stability of the financial system.  The Fed also provides services to depository institutions by playing a role in the nation’s payment system and by distributing coins and bills.

The Fed also determines monetary policy through the Federal Open Market Committee, or the FOMC.  The FOMC has 12 members:  The seven members of the Board of Governors, the president of the Federal Reserve Bank of New York and four at-large members.  The FOMC holds 8 scheduled meetings per year.  It is actually the FOMC that decides whether or not to change the federal funds rate.  This is rate we mean when we say the Fed raised or lowered rates.

Banks deposit money with the Fed and are required to maintain certain levels of reserves.  Some banks have excess reserves and others have too few.  Banks with excess reserves make overnight loans to banks with inadequate reserves.  The federal funds rate  is the rate banks charge each other for these overnight loans.  The FOMC targets a specific level by making more or less reserve balances available to the banking system.  The federal funds rates in turn, directly influences other rates such as deposit rates, prime rate, credit card rates and mortgage rates.  When the economy is growing too slowly, the FOMC lowers the target rate to stimulate economic growth.  When there is a danger of inflation from the economy growing too quickly, the FOMC will raise the target rate to slow demand and restrain inflation.

Inflation is a result of too much money chasing too few goods and services.  A stable price level is one of the Fed’s main goals.  When the economy experiences inflation, the purchasing power of the currency goes down, and if prices rise faster than personal income, the economy will experience a decrease in the standard of living. Prices naturally rise over time as the economy grows, but the important thing is the incomes keep up the increases in prices.

Hopefully, this will take a little bit of mystery about what the Fed is and the role it plays in our economy.  The Federal Reserve System is not perfect, but it has been successful in achieving its mission over time.

To hear the podcast of the Smart Money Management radio show on this topic, or others, go to our website at alderferbergen.com.

 The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. 

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