The role of the Federal Reserve has clearly evolved since its inception nearly 100 years ago. In recent years, the Fed has become more active in stabilizing the financial system, stimulating the U.S. economy with measures such as quantitative easing.
The Fed's early years
There was a financial crisis in 1907 when several banks failed, and panic swept across the nation, prompting a desire for changes to the banking system. The following year, Congress created the National Monetary Commission, which studied the existing banking structure and proposed a National Reserve Association.
In 1912, the House Banking and Currency Committee concluded that there was a monopoly on America's financial system and "a vast and growing concentration of control of money and credit in the hands of a comparatively few men."
On Dec. 23, 1913, the Federal Reserve was created when President Woodrow Wilson signed the Federal Reserve Act into law, which said that a central board was necessary to control and coordinate regional reserve banks.
The Fed today
Today, the Federal Reserve provides the United States with a safe, flexible and stable monetary and financial system. According to the Federal Reserve, the organization's responsibilities can be categorized four ways:
- Conducting the nation's monetary policy
- Supervising and regulating banks and other financial institutions
- Stabilizing the financial system
- Providing particular financial services to the U.S. government and financial institutions, as well as foreign official institutions
The Fed is often described as independent within the government, meaning that the Fed has been set up to ensure that monetary policy is not affected by political pressure. The Fed finances its own operations with its own resources. However, Congress can change laws governing the Fed, and the organization regularly updates Congress about professional matters.
The Federal Reserve is comprised of the board of governors in Washington, D.C., and 12 regional federal reserve banks in major American cities:
- New York
- St. Louis
- Kansas City
- San Francisco.
There are seven voting members of the Federal Open Market Committee (FOMC), which is responsible for the Fed's monetary policy. All seven members of the board of governors and five reserve bank presidents make up the FOMC.
The Fed describes monetary policy as actions undertaken by a central bank to influence the availability and cost of money and credit to help promote national economic goals. The board of governors has several tools available for controlling monetary policy. They include changing the federal funds rate, discount rate and rarely altering the level of reserves banks are required to hold.
The federal funds rate is the rate banks charge each other on overnight loans. The discount rate is the rate the Fed charges banks to borrow from it, and is nearly always set higher than the federal funds rate to discourage banks from borrowing from the central bank except in a "lender of last resort" scenario.
The Fed describes the reserve requirements as the amount of funds a depository institution must hold in reserve against deposit liabilities. Open market operations refer to the buying and selling of U.S. Treasury and federal agency securities, which ultimately affects the federal funds rate. This is the primary monetary policy tool, according to the Fed.
Essentially, the Fed hopes low interest rates will encourage consumers and businesses to take out loans, which they will use for purchases and investment, which will, in turn, boost the economy. The Fed can also raise interest rates to begin the opposite cycle if it thinks the economy is overheating.
More recently, the Fed has purchased huge swaths of various assets, in a process called quantitative easing, which was designed to ease strains on the financial and housing markets.