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What is the Federal Reserve System?

  • Riya Kumari
  • Dec 08, 2020
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‘Federal Reserve System’, the name itself gives hints that it is related to the monetary system. The Federal Reserve System which is also known as the Federal Reserve or Fed is the central bank of the United States. Congress has formulated this financial system for the nation's welfare by providing them such a safer, stable, and flexible monetary system. 


In simple language, we can say that the Federal Reserve System plays an extremely vital role in the US economy. There are several features, components of the Fed, even it affects employment. Now, you must be thinking about how it will affect employment? So, here is the answer to this question. 


At the point when the Fed brings down the Federal funds rate, banks and other monetary organizations ordinarily respond by bringing down the loan costs that they charge purchasers. This incorporates business loans and different types of credit that organizations depend on. This can straightforwardly decrease the unemployment rate by making it simpler and less expensive for a business to invest in and develop their organization.


Thus, here in this blog, we will learn several new things related to the Federal Reserve System, the definition of the Fed, why is Fed important, components, who owns the Federal reserve, the role of the Federal Reserve chair, Federal Reserve act, what does Fed do, and many more.


About the Federal Reserve System


The Federal Reserve System or popularly known as Fed, which is the central bank of the U.S., is the extensively strong monetary institution in the realm. The Fed comprises 12 regional Federal Reserve Banks that are each accountable for a particular geographic locale of the United States. Its fundamental tasks comprise administering national financial strategy, overseeing and governing banks, protecting economic vitality, and giving banking services.


Accordingly, we can speculate how important the Fed is for the economic system. By playing out the entirety of its different duties —setting loan costs, administering and directing monetary establishments, giving national payment services, and keeping up the dependability of the country's monetary system. The Fed plays a vital part in saving the health of the economy, particularly during times of financial emergency. 


Yet, even during times of monetary development, the activities that the Federal Reserve takes and the moves it doesn't make can have a genuine, important effect on your everyday life. A portion of these effects, for example, lower or higher consumer interest rate brought about by changes to the government subsidizes rate, are direct; others, for example, instabilities in stock costs, are indirect.


Thus, if you want to know in detail how the Federal reserve system works, then we need to first understand its structure. Here we will discern the three components of the Federal Reserve System.


  1. The whole Federal Reserve System was guided by the board of governors’ seven members. Their work is to supervise monetary policy, set the discount rate and the reserve requirement for member banks.


  1. The twelve regional Federal Reserve Banks work with the board to administer the country's commercial banks and execute strategy.


  1. The Federal Open Market Committee or FOMC manages open market operations. The seven board individuals, the president of the Federal Reserve Bank of New York, and four of the remaining 11 regional bank presidents are members. Thus, the FOMC meets eight times each year.


Congress made the Fed's board structure to guarantee its autonomy from governmental issues. Board members serve staggered terms of 14 years each. The president delegates another one at regular intervals and the U.S. Senate affirms them. If the staggered timetable is followed, at that point, no president or congressional party majority can control the board. (Also read: Reserve Bank of India (RBI): History, Objectives and Functions)


Who Owns the Federal Reserve?


If you think here you will find the name of a particular person as the owner of the Federal reserve system, then maybe you are not correct. Member commercial banks own the Federal Reserve by holding portions of the twelve Federal Reserve banks. But, this possession doesn't give them any leverage since they can't vote. The president, U.S. Treasury Department, and Congress don't sanction the Fed's choices, even though the board members are chosen by the president and endorsed by Congress. This gives chosen authorities power over the Fed's long term path yet not its everyday activities.


Role of the Federal Reserve Chair


Jerome Powell, a Fed board member is the current chairman of the Federal Reserve System, and his term as a chair is from 5 February 2018 to 5 February 2022. The Fed chair sets the path and complexion of both the Federal Reserve Board and the FOMC. The previous chair is Janet Yellen and her term ran from 2014 to 2018. Yellen's greatest concern was unemployment, which made her bound to the need to bring down interest rates. Unexpectedly, she was the chair when the economy required a contractionary monetary policy. 


Ben Bernanke was the chair from 2006 to 2014. He was a specialist on the Fed's part during the Great Depression, which was exceptionally lucky since it helped him find a way to end the 2008 monetary emergency. This assisted shield the financial circumstance from transforming into a downturn.



What is the 1913 Federal Reserve Act?


The 1913 Federal Reserve Act is US legislation that built the current Federal Reserve System. The Federal Reserve Act is one of the greatly powerful laws moulding the United States economic system. The law sets out the reason, structure, and function of the Federal Reserve System and congress can change the Federal Reserve Act and has done so a few times. 


Before 1913, monetary anxieties were regular events because investors were uncertain of the security of their bank stores. Private lenders, for example, J.P. Morgan, who rescued the central government in 1895, regularly gave credit extensions to give soundness in the monetary area.


The 1913 Federal Reserve Act, endorsed into law by President Woodrow Wilson, gave the 12 Federal Reserve banks the capacity to print cash to guarantee monetary soundness. Thus, the Federal Reserve System made the double order to boost employment and keep inflation low.



What does the Federal Reserve do?


Here, we will read in detail about the four functions of the Federal Reserve System.


1. Manages Inflation


This function of managing inflation is clearly visible. The Fed manages inflation and promotes maximum livelihood. Also, it assures interest rates remain reasonable over time. The Fed sets a 2 percent inflation target for the centre inflation rate and the centre rate strips out unstable food and gas costs. 


On Aug 27, 2020, the Fed reported it would endure inflation above 2% temporarily if it expanded employment. To measure inflation the Federal reserve system uses the Personal Consumption Expenditures Price Index or PCE. The Fed has numerous amazing assets available to it. The Fed's most useful asset is setting the objective for the Fed subsidized rate, which aids loan fees. 


The Fed additionally sets the reserve requirements for the country's banks. It mentions to them what level of their deposits they should have close by every night and the rest can be lent out. If a bank needs more money available toward the day's end, it gets what it needs from different banks. The funds it gets are known as the Fed funds and banks charge each other the Fed funds rate on these advances.



2. Supervises the Banking System


We have read above that the Fed is a system of 12 Federal Reserve banks under the supervision of the Board of Governors and these 12 banks both supervise and act as banks for commercial banks in their area. In simple language, we can say that the Fed supervises and governs the country’s biggest banks to safeguard customers. Also, Reserve banks perform an important study on financial topics.



3. Maintains the Stability of the Financial System


The 2008 economic crisis uncovered guidelines on individual banks were not sufficient. The monetary system had become so interconnected that the Fed and different controllers expected to take a gander at it in general. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 fortified the Fed's capacity to look after stability.



4. Provides Banking Services


The Fed is known as the "bankers' bank" because of each Reserve bank stores cash, processes checks, and makes credits for its members to meet their reserve requirements when required. Banks are charged the discount rate, which is somewhat higher than the Fed finances rate. (Recommended blog: Introduction to Investment Banking)





In conclusion, we can say that the Federal reserve system conducts a financial approach to oversee inflation, expand a business, and balance out interest rates. The Fed oversees the country's biggest banks and offers financial services to the U.S. government. It likewise advances the vitality of the monetary system. After reading the blog you must have realized the importance of the Federal Reserve System. 


We have seen so many things here like simple definitions of the Fed, its features, importance, who owns Fed, what does the Fed do, Federal reserve act, about its chair and its role, and many more such things in detail. The Fed performs several functions like it expands the security and wellness of individual monetary organizations and monitors their effect on the economic system as a whole.  It also enables payment and concession system protection and efficiency through assistance to the banking commerce and the U.S. government that facilitate the U.S. dollar trades and expenditures, and many more functions.

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