What Is the Federal Reserve System?:
- A seven-member Board of Governors that direct monetary policy.
- A 12-member Federal Open Market Committee (FOMC) that sets the target for the Fed funds rate, which guides interest rates. All Board members sit on the FOMC.
- Twelve regional member banks, located throughout the U.S., that supervise commercial banks and implement monetary policy.
- Staff economists who provide reports including the Beige Book and the Monetary Report to Congress.
The Function of the Federal Reserve System:
- Supervise the nation’s banking system to protect consumers.
- Maintain the stability of the financial markets and constrain potential crises.
- Be the central bank for other banks, the U.S. Government, and foreign banks.
How the Federal Reserve Manages Inflation:
When there is no risk of inflation, the Fed makes credit cheap by lowering interest rates. This increased liquidity, spurs business growth, and ultimately reduces unemployment. The Fed monitors inflation through the core inflation rate, as measured by the Consumer Price Index. The core inflation rate doesn't count volatile food and gas prices, which typically rise in the summer and fall in the winter -- too fast for the Fed to manage.
The Federal Reserve Sets Monetary Policy:
Federal Reserve Tools:
How the Federal Reserve Supervises the Banking System:
Known as the "bankers' bank," each Reserve bank stores currency, processes checks and, most importantly, makes loans for its members to make their reserve requirement when needed. These loans are made through the discount window, and are charged the discount rate (also set at the FOMC meeting). This rate is lower than the Fed funds rate, and LIBOR. However, most banks avoid using the discount window, as there is a certain stigma attached. It is assumed the bank can't get loans from other banks. That's why the Federal Reserve is known as the bank of last resort.
The 12 banks are located in: Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco. The Reserve Banks serve the U.S. Treasury by handling its payments, selling government securities and assisting with its cash management and investment activities. Reserve banks also conduct valuable research on economic issues. (Source: Federal Reserve Education The Structure of the Federal Reserve System)
The Fed's power over banks has been greatly enhanced with the Dodd-Frank Wall Street Reform Act. If any bank becomes too big to fail, it can be turned over to Federal Reserve supervision, which can then increase its reserve requirement enough to protect against any losses.
How the Federal Reserve Maintains the Stability of the Financial System:
Two decades earlier, the Federal Reserve intervened in the Long Term Capital Management Crisis. Federal Reserve actions actually worsened the Great Depression of 1929 by tightening the money supply to defend the gold standard.