The Federal Reserve System

What is the Fed?:

The Federal Reserve System (the Fed) was created by Congress in 1913 to be the nation’s central bank. It has four components:

• A seven-member Board of Governors, who set monetary policy,
• A 12 member Federal Open Market Committee (FOMC) who sets the Fed Funds Rate to be charged by Federal Reserve Banks. All Board members sit on the FOMC.
• Twelve regional member banks located throughout the U.S.
• Staff economists who provide reports including the Beige Book and the Monetary Report to Congress.

What is the Fed’s Function?:

The Fed’s most important and visible function is to control inflation without triggering a recession. In addition to that, the Fed has three other less visible functions:

1. Supervise the nation’s banking system to protect consumers.
2. Maintain the stability of the financial markets and constrain potential crises. (A good example of this is the handling of the Long Term Capital Management Crisis in 1998).
3. Be the Central Bank for other banks, the U.S. Government, and foreign banks.

How Does the Fed Affect the U.S. Economy?:

The Fed’s primary responsibility is to manage inflation. As the nation's central bank, the Fed loans money to the vast network of private banks. This gives it the power to regulate the economy by making the money it loans expensive (by raising interest rates) or cheap (by lowering rates).

Setting low interest rates is called expansionary monetary policy, and makes the economy grow faster. If the economy grows too fast, it triggers inflation. Ongoing inflation is like an insidious cancer that destroys any benefits of growth. Therefore, the Fed must be sure to keep rates high enough to prevent inflation.

How Does the Fed Affect You?:

The unlikely charisma of Former Fed Chair Alan Greenspan has made the Fed Chairman's position analogous to that of a rock star. Every utterance of Fed Chair Ben Bernanke and the other Federal Reserve Board members is scrutinized by the press for clues as to how the economy is performing, and whether the Fed will raise or lower rates at their next meeting.Therefore, the Fed directly affects your stock and bond mutual funds and your loan rates. By having such an influence on the economy, the Fed also indirectly affects your home's value and even the possibility that you may get laid off.