Federal Reserve Bank

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Federal Reserve System

The Federal Reserve System (the Fed) is the central bank of the United States. Created to provide a safe, flexible, and stable monetary and financial system, the Fed plays a central role in the U.S. economy through monetary policy, bank supervision, financial stability efforts, and the operation of key payment systems.

Brief history and purpose

The Fed was established by the Federal Reserve Act in 1913 in response to recurring financial panics that exposed weaknesses in the banking system. Its core purposes are:
* Maintain price stability.
* Promote maximum sustainable employment.
* Provide a stable and secure financial system and payments infrastructure.
* Serve as a lender of last resort to the banking system when necessary.

These goals are often referred to as the Fed’s “dual mandate”: price stability and maximum employment.

Organization and governance

The Federal Reserve System combines public and private elements:
* Board of Governors: A federal agency located in Washington, D.C., composed of seven governors nominated by the president and confirmed by the Senate. Governors serve staggered, long terms to promote continuity and limit short-term political influence.
* Twelve regional Federal Reserve Banks: Each serves a specific geographic district (e.g., New York, San Francisco, Chicago) and operates with a president and board of directors.
* Federal Open Market Committee (FOMC): The Fed’s main monetary policymaking body. It comprises the Board of Governors, the president of the Federal Reserve Bank of New York, and a rotating set of presidents from other regional banks.

Main duties and functions

The Fed’s responsibilities fall into four broad categories:

  1. Monetary policy
  2. Influence money and credit conditions to achieve the dual mandate.

  3. Use tools such as open market operations, interest on reserve balances (IORB), the discount rate, and standing facilities to steer short-term interest rates and the money supply.

  4. Supervision and regulation

  5. Oversee and regulate banks and other financial institutions to promote safety, soundness, and consumer protection.

  6. Financial stability

  7. Monitor and mitigate systemic risks. Act as lender of last resort during crises to preserve broader financial stability.

  8. Payments and services

  9. Operate core payment systems (e.g., Fedwire) and provide banking services to depository institutions and the U.S. government. Develop and modernize payments infrastructure (for example, the FedNow instant payments service).

How the Fed sets interest rates

The Fed targets a federal funds rate—the overnight rate banks charge each other—through several tools:
* Open market operations: Buying or selling government securities to add or drain reserves from the banking system.
* Interest on Reserve Balances (IORB): The rate paid on banks’ reserves sets an incentive for banks to hold reserves and helps establish a floor under short-term rates.
* Overnight Reverse Repurchase (ON RRP) facility: Provides a safe, short-term investment that helps set a floor for market rates.
* Discount window (discount rate): The rate the Fed charges banks for borrowing directly from the Fed, often serving as a backstop and influencing the top of the rate range.

By adjusting these tools and the supply of reserves, the Fed guides the effective federal funds rate toward its target and thereby influences broader financial conditions, borrowing costs, and economic activity.

Independence and accountability

The Fed is operationally independent: its policy decisions do not require approval from the president or Congress. Independence aims to reduce short-term political pressures that could lead to destabilizing monetary policy. At the same time, the Fed is accountable to Congress, reports regularly on its actions, and operates within the legal framework set by legislation.

Payments, liquidity, and modernization

  • Fedwire: The Fed’s large-value, same-day payment and settlement system that moves trillions daily among financial institutions.
  • FedNow: A real-time payments service introduced to enable instant payments and reduce settlement lags.
    The Fed also encourages banks to monitor intraday liquidity and credit risk more closely to reduce settlement risks.

Funding and remittances to the Treasury

The Fed earns income primarily from interest on securities acquired through open market operations. It also earns interest on foreign currency holdings, loans to depository institutions, and fees for services. After covering operating expenses, the Fed transfers the remaining earnings to the U.S. Treasury.

Presidential influence

The president influences the Fed mainly through nominations to the Board of Governors, including the Fed Chair. Appointees are confirmed by the Senate and serve fixed terms, which helps preserve the Fed’s operational independence.

What might happen without the Fed

Without a central bank, there would be no lender of last resort, less coordinated oversight of money supply and interest rates, and a greater likelihood of bank runs, unstable credit conditions, and recurring financial panics.

Key takeaways

  • The Federal Reserve System is the U.S. central bank responsible for monetary policy, bank supervision, financial stability, and payment systems.
  • Its dual mandate is price stability and maximum sustainable employment.
  • The Fed’s governance combines a federal Board of Governors, twelve regional Reserve Banks, and the FOMC for monetary policy decisions.
  • It uses multiple tools—open market operations, IORB, ON RRP, and the discount window—to influence short-term interest rates and liquidity.
  • The Fed is operationally independent but accountable to Congress and operates within a statutory framework.

Selected sources for further reading

  • Federal Reserve Board — About the Fed
  • Federal Reserve Board — Structure of the Federal Reserve System
  • Federal Reserve Board — Monetary Policy Principles and Practice
  • Federal Reserve — FedNow Services