Federal Reserve
The Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of financial panics led to the desire for central control of the monetary system in order to alleviate financial crises. Although an instrument of the U.S. government, 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 by anyone else in the executive or legislative branches of government, it does not receive funding appropriated by Congress, and the terms of the members of the board of governors span multiple presidential and congressional terms." Over the years, events such as the Great Depression in the 1930s and the Great Recession during the 2000s have led to the expansion of the roles and responsibilities of the Federal Reserve System.
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 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 Fed also conducts research into the economy and provides numerous publications, such as the Beige Book and the FRED database.
The Federal Reserve System is composed of several layers. It is governed by the presidentially appointed board of governors or Federal Reserve Board. Twelve regional Federal Reserve Banks, located in cities throughout the nation, regulate and oversee privately owned commercial banks. Nationally chartered commercial banks are required to hold stock in, and can elect some board members of, the Federal Reserve Bank of their region.
The Federal Open Market Committee sets monetary policy by adjusting the target for the federal funds rate, which generally influences market interest rates and, in turn, US economic activity via the monetary transmission mechanism. The FOMC consists of all seven members of the board of governors and the twelve regional Federal Reserve Bank presidents, though only five bank presidents vote at a time: the president of the New York Fed and four others who rotate through one-year voting terms. There are also various advisory councils. It has a structure unique among central banks, and is also unusual in that the United States Department of the Treasury, an entity outside of the central bank, prints the currency used.
The federal government sets the salaries of the board's seven governors, and it receives all the system's annual profits after dividends on member banks' capital investments are paid, and an account surplus is maintained. In 2015, the Federal Reserve earned a net income of $100.2 billion and transferred $97.7 billion to the U.S. Treasury, and 2020 earnings were approximately $88.6 billion with remittances to the U.S. Treasury of $86.9 billion.
The Federal Reserve has been criticized for its approach to managing inflation, perceived lack of transparency, and its role in economic downturns. Figures such as Milton Friedman and Ron Paul have argued that its actions, such as expansionary policies and bailouts, contribute to inflation, asset bubbles, and moral hazard. Critics have also noted that the shift from the gold standard to fiat currency has led to long-term inflation and financial instability, with some calling for the Fed's abolition or greater accountability through audits.
Purpose
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. The primary declared motivation for creating the Federal Reserve System was to address banking panics. Other stated purposes, are "to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States".Today, the purposes of the Federal Reserve include the responsibilities to:
- Address the problem of banking panics
- Serve as the central bank for the United States
- Balance private interests of banks and the centralized responsibility of government
- * Supervise and regulate banking institutions
- * Protect the credit rights of consumers
- Conduct monetary policy by influencing market interest rates to achieve the goals of
- * Maximum employment
- * Stable prices, interpreted as an inflation rate of 2 percent per year on average
- * Moderate long-term interest rates
- Maintain the stability of the financial system and contain systemic risk in financial markets
- Provide financial services to depository institutions, the U.S. government, and foreign official institutions
- * Facilitate the exchange of payments among regions and the operation of the nation's payments system
- * Respond to local liquidity needs
- Strengthen U.S. standing in the world economy
Fractional-reserve bank
Check clearing system
Before the establishment of the Federal Reserve, during times of economic uncertainty, some banks refused to clear checks from certain other banks, which led to large-scale bank failure in the early 20th-century. Hence, a national check-clearing system was created in the Federal Reserve System. The Federal Reserve can physically accept and transport cheques.Lender of last resort
In the United States of America, the Federal Reserve serves as the lender of last resort to those institutions that cannot obtain credit elsewhere, institutions the collapse of which would have serious implications for the economy. It took over this role from the private sector clearing houses which operated during the Free Banking Era. The availability of liquidity is intended to prevent bank runs.Fluctuations
Reserve Banks provide liquidity to banks to meet short-term needs stemming from seasonal fluctuations in deposits or unexpected withdrawals through its discount window and credit operations. Longer-term liquidity may also be provided in exceptional circumstances. The rate the Fed charges banks for these loans is called the discount rate. By making these loans, the Fed serves as a buffer against unexpected 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. For example, on September 16, 2008, the Federal Reserve Board authorized an $85 billion loan to stave off the bankruptcy of international insurance giant American International Group.Central bank
As the central bank of the United States, the Fed serves as a banker's bank and as the government's bank. As the banker's bank, it helps to assure the safety and efficiency of the payments system. As the government's bank or fiscal agent, the Fed processes a variety of financial transactions involving trillions of dollars. 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, notes and bonds. 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. The Federal Reserve Banks then distribute it to other financial institutions in various ways. During the Fiscal Year 2020, the Bureau of Engraving and Printing delivered 57.95 billion notes at an average cost of 7.4 cents per note.Federal funds
Federal funds, officially Federal Reserve Deposits, 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 purpose of keeping funds at a Federal Reserve Bank is to have a mechanism for private banks to lend funds to one another. This market for funds plays an important role in the Federal Reserve System as it is the basis for its monetary policy work. Monetary policy is put into effect partly by influencing how much interest the private banks charge each other for the lending of these funds. Federal reserve accounts contain federal reserve credit, which can be converted into federal reserve notes.Bank regulator
The Federal Reserve regulates private banks. The system was designed out of a compromise between the competing philosophies of privatization and government regulation. In 2006 Donald L. Kohn, vice chairman of the board of governors, summarized the history of this compromise:In the structure of the Federal Reserve 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 United States Senate.