The Federal Reserve System (“the Fed”) is the central bank of the United States, founded in 1913, to ensure economic stability, provide certain financial services and conduct national monetary policy.
Central banks are financial institutions tasked with formulating monetary policy, regulating member banks and distributing money. The U.S. Federal Reserve is an independent institution that acts outside government pressures, though it’s still subject to congressional oversight.
The Fed is mandated to ensure financial stability by minimizing price volatility, maximizing stable employment and moderating long-term interest rates. It achieves these goals by:
Additionally, it acts as the lender of last resort to member banks who can’t borrow funds elsewhere.
The Federal Reserve is made up of three main bodies:
The overarching institution is led by a Chairman who heads the 7-person Board of Directors. Each member is nominated by the president and approved by the senate. Their primary responsibilities include setting cash reserve requirements and interest rates for lending to other banks.
The Board of Directors is part of the 12-person FOMC, which also seats 5 presidents from the 12 regional banks in rotation. The FOMC is responsible for:
Additionally, the FOMC handles open market operations (OMOs) like buying and selling government securities.
The Fed’s primary source of income is derived from the interest earned on U.S. government securities acquired through OMO, foreign currency investments and loans to depository institutions. After paying expenses, the Fed transfers surplus funds to the U.S. Treasury.
The decisions made by the Federal Reserve ripple outward from financial institutions into the broader U.S. economy. For instance, the Fed:
Additionally, the Fed is also responsible for correcting financial instability during recessions. For instance, in both 2008 and 2020, it used quantitative easing to lower interest rates and increase economic activity.
While the economy and stock market are separate entities, the Federal Reserve holds the power to sway both. For instance, it’s actions and policies can impact:
In other words: When the Federal Reserve acts, it’s wise to pay attention.
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