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.

🤔 Understanding the Federal Reserve

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.

Responsibilities of the Federal Reserve

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:

• Influencing financial conditions and conducting monetary policy
• Supervising banking institutions to protect consumers and the financial system
• Maintaining financial stability by containing economic risk
• Providing financial services to member banks, depository institutions and the U.S. government 

Additionally, it acts as the lender of last resort to member banks who can’t borrow funds elsewhere.

Federal Reserve structure

The Federal Reserve is made up of three main bodies:

• The Federal Reserve Board of Governors
• The Federal Open Market Committee (FOMC)
• 12 Federal Reserve banks spread across the nation

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:

• Managing the money supply
• Stabilizing prices
• Maximizing employment
• Moderating long-term interest rates

Additionally, the FOMC handles open market operations (OMOs) like buying and selling government securities.

Federal Reserve sources of income

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.

What this means for you

The decisions made by the Federal Reserve ripple outward from financial institutions into the broader U.S. economy. For instance, the Fed:

• Manages inflation and encourages (or discourages) consumer lending and spending by regulation of interest rates
• Protects the economy and consumers’ savings by supervising banking activities
• Influences interest rates on mortgages, credit cards and car loans by regulating the Federal Funds Rate
• Moderates unemployment rates by injecting money into the financial system

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:

• Long- and short-term borrowing costs
• The interest rates and prices on your government bonds
• Stock prices (for instance, by instituting policies that affect business’ profits) 

In other words: When the Federal Reserve acts, it’s wise to pay attention.