Source: Investopedia
Most people are aware that there is a government body that acts as the guardian of the economy - an economic sentinel who implements policies designed to keep the country operating smoothly.
In the U.S., the answer lies in the role of the Federal Reserve, or simply, the Fed. The Fed is the gatekeeper of the U.S. economy. It is the bank of the U.S. government and, as such, it regulates the nation's financial institutions. The Fed watches over the world's largest economy and is, therefore, one of the most powerful organizations on earth.
The Federal Reserve was created by the U.S. Congress in 1913. Before that, the U.S. lacked any formal organization for studying and implementing monetary policy. Consequently markets were often unstable and the public had very little faith in the banking system. The Fed is an independent entity, but is subject to oversight from Congress. Basically, this means that decisions do not have to be ratified by the President or anyone else in the government, but Congress periodically reviews the Fed's activities.
The Fed is headed by a government agency in Washington known as the Board of Governors of the Federal Reserve. The Board of Governors consists of seven presidential appointees, each of whom serves 14 year terms. All members must be confirmed by the Senate and can be reappointed. The board is led by a chairman and a vice chairman, each appointed by the President and approved by the Senate for four-year terms. The current chair is Ben Bernanke, who took over for Alan Greenspan on February 1, 2006. Greenspan had been chairman since 1987.
There are 12 regional Federal Reserve Banks located in major cities around the country that operate under the supervision of the Board of Governors. Reserve Banks act as the operating arm of the central bank and do most of the work of the Fed. The banks generate their own income from four main sources:
Most people are aware that there is a government body that acts as the guardian of the economy - an economic sentinel who implements policies designed to keep the country operating smoothly.
In the U.S., the answer lies in the role of the Federal Reserve, or simply, the Fed. The Fed is the gatekeeper of the U.S. economy. It is the bank of the U.S. government and, as such, it regulates the nation's financial institutions. The Fed watches over the world's largest economy and is, therefore, one of the most powerful organizations on earth.
The Federal Reserve was created by the U.S. Congress in 1913. Before that, the U.S. lacked any formal organization for studying and implementing monetary policy. Consequently markets were often unstable and the public had very little faith in the banking system. The Fed is an independent entity, but is subject to oversight from Congress. Basically, this means that decisions do not have to be ratified by the President or anyone else in the government, but Congress periodically reviews the Fed's activities.
The Fed is headed by a government agency in Washington known as the Board of Governors of the Federal Reserve. The Board of Governors consists of seven presidential appointees, each of whom serves 14 year terms. All members must be confirmed by the Senate and can be reappointed. The board is led by a chairman and a vice chairman, each appointed by the President and approved by the Senate for four-year terms. The current chair is Ben Bernanke, who took over for Alan Greenspan on February 1, 2006. Greenspan had been chairman since 1987.
There are 12 regional Federal Reserve Banks located in major cities around the country that operate under the supervision of the Board of Governors. Reserve Banks act as the operating arm of the central bank and do most of the work of the Fed. The banks generate their own income from four main sources:
- Services provided to banks
- Interest earned on government securities acquired while carrying out the work of the Federal Reserve
- Income from foreign currency held
- Interest on loans to depository institutions
The income gathered from these
activities is used to finance day to day operations, including
information gathering and economic research. Any excess income is funneled back
into the U.S. Treasury.
The system also includes the Federal Open Market Committee, better known as the FOMC. This is the policy-making branch of the Federal Reserve. Traditionally, the chair of the board is also selected as the chair of the FOMC. The voting members of the FOMC are the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York and presidents of four other Reserve Banks who serve on a one-year rotating basis. All Reserve Bank presidents participate in FOMC policy discussions whether they are voting members or not. The FOMC makes the important decisions on interest rate and other monetary policies. This is the reason why they get most of the attention in the media.
The system also includes the Federal Open Market Committee, better known as the FOMC. This is the policy-making branch of the Federal Reserve. Traditionally, the chair of the board is also selected as the chair of the FOMC. The voting members of the FOMC are the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York and presidents of four other Reserve Banks who serve on a one-year rotating basis. All Reserve Bank presidents participate in FOMC policy discussions whether they are voting members or not. The FOMC makes the important decisions on interest rate and other monetary policies. This is the reason why they get most of the attention in the media.
The Fed's mandate is "to
promote sustainable growth, high levels of employment, stability of prices to
help preserve the purchasing power of the dollar and moderate long-term interest rates."
In other words, the Fed's job is to foster a sound banking system and a healthy economy. To accomplish its mission, the Fed serves as the banker's bank, the government's bank, the regulator of financial institutions and as the nation's money managers.
The term monetary policy refers to the actions that the Federal Reserve undertakes to influence the amount of money and credit in the U.S. economy. Changes to the amount of money and credit affect interest (the cost of credit) and the performance of the U.S. economy. To state this concept simply, if the cost of credit is reduced, more people and firms will borrow money and the economy will heat up.
The FOMC typically meets eight times each year. At these meetings, the FOMC members decide whether monetary policy should be changed. Before each meeting, FOMC members receive the "Green Book," which contains the Federal Reserve Board (FRB) staff forecasts of the U.S. economy, the "Blue Book," which presents the Board staff's monetary policy analysis and the "Beige Book," which includes a discussion of regional economic conditions prepared by each Reserve Bank.
When the FOMC meets, it decides whether to lower, raise or maintain its target for the federal funds rate. The FOMC also decides on the discount rate. The reason we say that the FOMC sets the target for the rate is because the rate is actually determined by market forces. The Fed will do its best to influence open-market operations, but many other factors contribute to what the actual rate ends up being. A good example of this phenomenon occurs during the holiday season. At Christmas, consumers have an increased demand for cash, and banks will draw down on their reserves, placing a higher demand on the overnight reserve market; this increases the federal funds rate. So when the media says there is a change in the federal funds rate (in basis points), don't let it confuse you; what they are, in fact, referring to is a change in the Fed's target.
If the FOMC wants to increase economic growth, it will reduce the target fed funds rate. Conversely, if it wants to slow down the economy, it will increase the target rate.
The Fed tries to sustain steady growth, without the economy overheating. When talking about economic growth, extremes are always bad. If the economy is growing too fast, we end up with inflation. If the economy slows down too much, we end up in recession.
Sometimes the FOMC maintains rate at current levels but warns that a possible policy change could occur in the near future. This warning is referred to as the bias. The means that the Fed might think that rates are fine for now, but that there is a considerable threat that economic conditions could warrant a rate change soon. The Fed will issue an easing bias if it thinks the lowering of rates is imminent. Conversely, the Fed will adopt a bias towards tightening if it feels that rates might rise in the future.
The Fed has more power and influence on financial markets than any legislative entity. Its monetary decisions are intensely observed and often lead the way for other countries to take the same policy changes.
Finally, all national banks and some state-chartered banks are part of the Federal Reserve System. They are referred to as member banks.
The Fed's mandate is "to promote sustainable growth, high levels of employment, stability of prices to help preserve the purchasing power of the dollar and moderate long-term interest rates."
In other words, the Fed's job is to foster a sound banking system and a healthy economy. To accomplish its mission, the Fed serves as the banker's bank, the government's bank, the regulator of financial institutions and as the nation's money manager.
Let's recap
In other words, the Fed's job is to foster a sound banking system and a healthy economy. To accomplish its mission, the Fed serves as the banker's bank, the government's bank, the regulator of financial institutions and as the nation's money managers.
The term monetary policy refers to the actions that the Federal Reserve undertakes to influence the amount of money and credit in the U.S. economy. Changes to the amount of money and credit affect interest (the cost of credit) and the performance of the U.S. economy. To state this concept simply, if the cost of credit is reduced, more people and firms will borrow money and the economy will heat up.
The FOMC typically meets eight times each year. At these meetings, the FOMC members decide whether monetary policy should be changed. Before each meeting, FOMC members receive the "Green Book," which contains the Federal Reserve Board (FRB) staff forecasts of the U.S. economy, the "Blue Book," which presents the Board staff's monetary policy analysis and the "Beige Book," which includes a discussion of regional economic conditions prepared by each Reserve Bank.
When the FOMC meets, it decides whether to lower, raise or maintain its target for the federal funds rate. The FOMC also decides on the discount rate. The reason we say that the FOMC sets the target for the rate is because the rate is actually determined by market forces. The Fed will do its best to influence open-market operations, but many other factors contribute to what the actual rate ends up being. A good example of this phenomenon occurs during the holiday season. At Christmas, consumers have an increased demand for cash, and banks will draw down on their reserves, placing a higher demand on the overnight reserve market; this increases the federal funds rate. So when the media says there is a change in the federal funds rate (in basis points), don't let it confuse you; what they are, in fact, referring to is a change in the Fed's target.
If the FOMC wants to increase economic growth, it will reduce the target fed funds rate. Conversely, if it wants to slow down the economy, it will increase the target rate.
The Fed tries to sustain steady growth, without the economy overheating. When talking about economic growth, extremes are always bad. If the economy is growing too fast, we end up with inflation. If the economy slows down too much, we end up in recession.
Sometimes the FOMC maintains rate at current levels but warns that a possible policy change could occur in the near future. This warning is referred to as the bias. The means that the Fed might think that rates are fine for now, but that there is a considerable threat that economic conditions could warrant a rate change soon. The Fed will issue an easing bias if it thinks the lowering of rates is imminent. Conversely, the Fed will adopt a bias towards tightening if it feels that rates might rise in the future.
The Fed has more power and influence on financial markets than any legislative entity. Its monetary decisions are intensely observed and often lead the way for other countries to take the same policy changes.
Finally, all national banks and some state-chartered banks are part of the Federal Reserve System. They are referred to as member banks.
The Fed's mandate is "to promote sustainable growth, high levels of employment, stability of prices to help preserve the purchasing power of the dollar and moderate long-term interest rates."
In other words, the Fed's job is to foster a sound banking system and a healthy economy. To accomplish its mission, the Fed serves as the banker's bank, the government's bank, the regulator of financial institutions and as the nation's money manager.
Let's recap
- The Federal Reserve Board was created to in 1913 to provide the nation with a safer, more flexible and more stable monetary and financial system.
- The Board of Governors of the Federal Reserve heads up the Fed.
- Twelve Regional Federal Reserve Banks are the operating arms of the Fed.
- The Federal Open Market Committee (FOMC) is the policy-making branch of the Federal Reserve.
- The Fed's mandate is "to promote sustainable growth, high levels of employment, stability of prices to help preserve the purchasing power of the dollar and moderate long-term interest rates."
- The Fed
serves as the banker's bank, the government's bank, the regulator of
financial institutions and as the nation's money manager.
- Monetary policy is influenced through open-market operations, the discount rate and reserve requirements.
- The FOMC sets a target for the federal funds rate and attempts to reach that rate primarily through the use of open market operations.
- The FOMC typically meets eight times per year to make decisions on monetary policy.
- If the FOMC wants to increase economic growth, it will reduce the target federal funds rate (and vice versa).
- If the target rate has been increased, the FOMC sells securities. If the FOMC reduces the target rate, they buy securities.
- Reducing the target rate means that the fed is putting more money into the economy (and vice versa).
- Chairman of the Fed, Ben Bernanke took over the position from Alan Greenspan on February 1, 2006. Greenspan had held the position since 1987.
