Federal Reserve – Central Banking System Of United States

The Federal Reserve System—also known as the Federal Reserve or simply as the Fed—is the central banking system of the United States. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907.

Over time, the roles and responsibilities of the Federal Reserve System have expanded, and its structure has evolved. Events such as the Great Depression in the 1930s were major factors leading to changes in the system.

The U.S. Congress established three key objectives for monetary policy in the Federal Reserve Act: maximizing employment, stabilizing prices, and moderating long-term interest rates. The first two objectives are sometimes referred to as the Federal Reserve’s dual mandate.

Its duties have expanded over the years, and as of 2009 also include supervising and regulating banks, maintaining the stability of the financial system and providing financial services to depository institutions, the U.S. government, and foreign official institutions.

The Federal Reserve System’s structure is composed of the presidentially appointed Board of Governors or Federal Reserve Board (FRB), partially presidentially appointed Federal Open Market Committee (FOMC), twelve regional Federal Reserve Banks located in major cities throughout the nation, numerous privately owned U.S. member banks, and various advisory councils.

PURPOSE

The Federal Reserve System considers itself an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.

The U.S. Government receives all the system’s annual profits, after a statutory dividend of 6% on member banks’ capital investment is paid. In 2015, the Federal Reserve made a profit of $100.2 billion and transferred $97.7 billion to the U.S. Treasury

The primary motivation for creating the Federal Reserve System was to address banking panics. Other purposes are stated in the Federal Reserve Act, Before the founding of the Federal Reserve System, the United States underwent several financial crises.

A particularly severe crisis in 1907 led Congress to enact the Federal Reserve Act in 1913. Today the Federal Reserve System has responsibilities in addition to ensuring the stability of the financial system.

To serve as the central bank for the United States

To strike a balance between private interests of banks and the centralized responsibility of government

To supervise and regulate banking institutions

To manage the nation’s money supply through monetary policy to achieve the sometimes-conflicting goals of maximum employment

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LENDER OF LAST RESORT

Banking institutions in the United States are required to hold reserves—amounts of currency and deposits in other banks, equal to only a fraction of the amount of the bank’s deposit liabilities owed to customers. This practice is called fractional-reserve banking. As a result, banks usually invest the majority of the funds received from depositors.

In the United States, the Federal Reserve serves as the lender of last resort to those institutions that cannot obtain credit elsewhere and the collapse of which would have serious implications for the economy.

Because some banks refused to clear checks from certain others during times of economic uncertainty, a check-clearing system was created in the Federal Reserve System.

By creating the Federal Reserve System, Congress intended to eliminate the severe financial crises that had periodically swept the nation, especially the sort of financial panic that occurred in 1907. Many banks and clearinghouses refused to clear checks drawn on certain other banks, a practice that contributed to the failure of otherwise solvent banks.

Through its discount window and credit operations, Reserve Banks provide liquidity to banks to meet short-term needs stemming from fluctuations in deposits or unexpected withdrawals.

The Fed serves as a buffer against day-to-day fluctuations in reserve demand and supply. This contributes to the effective functioning of the banking system, alleviates pressure in the reserves market and reduces the extent of unexpected movements in the interest rates.

CENTRAL BANK

In its role as the central bank of the United States, the Fed serves as a banker’s bank and as the government’s bank. it helps to assure the safety and efficiency of the payments system. As the government’s bank, the Fed processes a variety of financial transactions involving trillions of dollars.

Just as an individual might keep an account at a bank, the U.S. Treasury keeps a checking account with the Federal Reserve, through which incoming federal tax deposits and outgoing government payments are handled.

As part of this service relationship, the Fed sells and redeems U.S. government securities such as savings bonds and Treasury bills. It also issues the nation’s coin and paper currency.

The U.S. Treasury, through its Bureau of the Mint and Bureau of Engraving and Printing, actually produces the nation’s cash supply and, in effect, sells the paper currency to the Federal Reserve Banks at manufacturing cost, and the coins at face value.

Federal funds are the reserve balances that private banks keep at their local Federal Reserve Bank.These balances are the namesake reserves of the Federal Reserve System.

The balance between private interests and government can also be seen in the structure of the system. Private banks elect members of the board of directors at their regional Federal Reserve Bank while the members of the Board of Governors are selected by the President of the United States and confirmed by the Senate.

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GOVERNMENT REGULATION AND SUPERVISION

In the Federal Reserve System, the Board of Governors has a number of supervisory and regulatory responsibilities in the U.S. banking system, but not complete responsibility.

This Board also plays a major role in the supervision and regulation of the U.S. banking system. It has supervisory responsibilities for state-chartered banks that are members of the Federal Reserve System, bank holding companies (companies that control banks), the foreign activities of member banks, the U.S. activities of foreign banks,

The Federal Reserve System has a “unique structure that is both public and private” and is described as “independent within the government” rather than “independent of government”.

The seven-member Board of Governors is a federal agency. It is charged with the overseeing of the District Reserve Banks and setting national monetary policy. It also supervises and regulates the U.S. banking system in general.

FEDERAL RESERVE BANKS

There are 12 Federal Reserve Banks and they are located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. Each reserve Bank is responsible for member banks located in its district.

The size of each district was set based upon the population distribution of the United States when the Federal Reserve Act was passed. Each regional Bank has a president, who is the chief executive officer of their Bank.

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MONETARY POLICY

The term “monetary policy” refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals.

What happens to money and credit affects interest rates (the cost of credit) and the performance of an economy. The Federal Reserve Act of 1913 gave the Federal Reserve authority to set monetary policy in the United States.

The Federal Reserve sets monetary policy by influencing the federal funds rate, which is the rate of interbank lending of excess reserves. The rate that banks charge each other for these loans is determined in the interbank market and the Federal Reserve influences this rate through the three “tools” of monetary policy described in the Tools section below.

MARKET FOR BALANCES

The Federal Reserve implements U.S. monetary policy by affecting conditions in the market for balances that depository institutions hold at the Federal Reserve Banks. By conducting open market operations, imposing reserve requirements, permitting depository institutions to hold contractual clearing balances, and extending credit through its discount window facility.

Effects on the quantity of reserves that banks used to make loans influence the economy. Policy actions that add reserves to the banking system encourage lending at lower interest rates thus stimulating growth in money, credit, and the economy.

The Federal Reserve System implements monetary policy largely by targeting the federal funds rate. This is the interest rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed.