The Federal Reserve System - Part 1: Purpose and Organization

Part 1: Purpose and Organization

The Federal Reserve System was created by the United States Congress in 1913 in order to provide a safer, more flexible banking and monetary system. Over time, this original function evolved into the broader economic and financial objectives of facilitating the solidity and growth of the national economy, maintaining a high level of employment, ensuring stability in the purchasing power of the dollar, and maintaining reasonable balance in transactions with foreign countries.

As the nation’s central bank, the Federal Reserve (or Fed, as it’s commonly called) contributes to the realization of these objectives with its ability to influence money and credit in the economy. Although but one of many forces affecting interest rates and the economy as a whole, the Fed arguably wields the most significant influence on the nation’s financial pathway.

The governing body of the Federal Reserve is its Board of Governors, which is located in Washington, D.C. The seven members of the Board are appointed to fourteen-year terms by the President, subject to confirmation by the Senate. The Chairman and Vice-Chairman are selected from Board members for four-year terms, also by the President with Senate confirmation. Although appointed, the Board is not a part of the Administration; it is an independent agency of the federal government, though Congress has the authority to change its powers and duties by legislation.

The members of the Board are part of the Federal Open Market Committee (FOMC). Other members of the twelve-seat committee include the president of the Federal Reserve Bank of New York and four additional Federal Reserve Bank presidents, who serve on a rotating basis. The FOMC directs the Federal Reserve’s open market operations -- the purchasing and selling of U.S. Treasury and federal agency securities -- which is the Fed’s principal tool for executing monetary policy.

The United States is divided into twelve Federal Reserve Districts, each with a district Federal Reserve Bank and its own president and directors. These banks make recommendations to the Federal Reserve Board for changes in the discount rate, which is the interest rate that financial institutions are charged to borrow money from the Reserve. Also, these banks hold the reserve balances for their depository institutions, make loans to those institutions, supply currency, collect and clear checks, and handle U.S. government debt and cash balances.

In addition to regulating the supply of reserves in its efforts to influence economic activity, the Fed, in close cooperation with the U.S. Treasury, also has the function of acting for the government in foreign exchange markets. The Fed watches international developments, such as interest rate changes abroad, in order to moderate their effects on the U.S. economy.

The Fed also shares supervisory and regulatory functions with other federal banking agencies. It supervises state-chartered banks that are members of the Federal Reserve System as well as all bank holding companies. The Fed also acts as the banker for the federal government, sets margin requirements for the purchase or carrying of equity securities, and establishes and enforces rules which protect consumers in financial operations. Still, the Fed’s most important function is its control over banking reserves.

Not all banks are members of the Federal Reserve System. National banks chartered by the federal government must belong to the system; state banks may also be members. Since 1980, however, all depository institutions (which include commercial banks, savings banks, savings and loans, credit unions, and foreign-related banking institutions) are required to maintain reserves with the Federal Reserve System. They may also borrow funds from the Reserve as necessary.

Part 2 of this series will explore how the Federal Reserve regulates reserves and influences the national economy.

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