Federal Reserve System (FRS)

Federal Reserve System (FRS): Functions and History

What is the Federal Reserve System?

The Federal Reserve System (the Fed) is the central bank of the United States, established by the Federal Reserve Act in 1913. It comprises a central agency in Washington, D.C. (the Board of Governors) and 12 regional Federal Reserve Banks located across the country. Its central role is to implement monetary policy and promote a stable, well-functioning financial system.

Structure and Governance

• Board of Governors: A multi-member board based in Washington that provides policy oversight.
• 12 Regional Reserve Banks: Operate in major cities and provide services to local financial institutions.
• Federal Open Market Committee (FOMC): The Fed’s monetary policy–making body (see below).

Board members are nominated by the president and confirmed by the Senate. The Fed also serves as the lender of last resort to member institutions.

Core Functions

The Fed performs several broad functions to support the economy and financial system:
– Conduct monetary policy to influence economic activity and inflation.
– Promote financial system stability and reduce systemic risk.
– Supervise and regulate financial institutions to ensure safety and soundness.
– Provide financial services to banks and the U.S. government (including payment and settlement systems).
– Protect consumers through supervision, regulation, research, and enforcement.

Payment and Settlement Systems

The Fed operates key wholesale payment systems:
– Fedwire Funds Service: A real-time gross settlement system for immediate, final, and irrevocable large-value transfers between institutions.
– Fedwire Securities Service: Processes securities transfers.
– National Settlement Service: Facilitates multilateral settlement.
– FedNow: A newer service enabling instant retail payments around the clock so funds can be sent and received within seconds.

Monetary Policy and the FOMC

The FOMC sets U.S. monetary policy and manages the country’s money supply. It includes:
– The Board of Governors,
– The president of the Federal Reserve Bank of New York,
– Four of the remaining 11 regional Reserve Bank presidents on a rotating basis.

The FOMC meets regularly to set a target range for the federal funds rate, which influences short-term interest rates across the economy. When the Fed wants to stimulate economic activity, it typically lowers the target; to cool an overheated economy, it raises the target.

Historical Highlights

• 1913: Federal Reserve created in response to financial instability and bank runs.
• Discount window: Established as a facility for banks to borrow short-term liquidity from their local Reserve Bank.
• 1930s Reforms: Banking Acts of 1933 and 1935 strengthened the central board’s authority and reshaped the Fed after the Great Depression.
• 1977 Reform: The Fed was required to report to Congress on progress toward maximum employment and inflation objectives.
• Long-run inflation goal: The Fed targets an average inflation rate of about 2% over the long run.

Policy Goals and Tools

The Fed’s statutory goals are:
– Maximum employment
– Stable prices
– Moderate long-term interest rates

Primary tools used to pursue these goals include:
– Open market operations (buying/selling securities)
– Setting the federal funds rate (and related interest rate corridors)
– Discount window lending and emergency liquidity facilities
– Reserve requirements and regulatory supervision
– Unconventional tools such as quantitative easing when needed

Funding

The Fed funds its operations primarily through interest earned on securities acquired in open-market operations and fees charged for banking services. It does not rely on congressional appropriations for routine funding.

Why the Fed Matters

Before the Fed, bank runs and financial panics were common. The central bank provides a framework for monetary policy, overseen banking supervision, and payment system infrastructure — all of which help stabilize the financial system and support economic activity.

Conclusion

The Federal Reserve System is the United States’ central bank, responsible for monetary policy, financial stability, bank supervision, and critical payment services. Its actions influence employment, inflation, interest rates, and the overall functioning of the U.S. economy.