What Is the Federal Reserve System (FRS)?

The Federal Reserve System (FRS), often just called "the Fed," is the central bank of the United States and arguably the most powerful financial institution in the world. It was founded to provide the country with a safe, flexible, and stable monetary and financial system. The Fed is composed of 12 regional Federal Reserve Banks that are each responsible for a specific geographic area of the U.S.

Key Takeaways

  • The Federal Reserve System is the central bank of the United States.
  • The FRS provides the country with a safe, flexible, and stable monetary and financial system.
  • Known simply as the Fed, it is composed of 12 regional Federal Reserve Banks that are each responsible for a specific geographic area of the U.S.
  • The Fed's main duties include conducting national monetary policy, supervising and regulating banks, maintaining financial stability, and providing banking services.

Understanding the Federal Reserve System

The Federal Reserve was founded by U.S. Congress in 1913. Its creation was precipitated by repeated financial panics that afflicted the U.S. economy over the previous century, leading to severe economic disruptions due to bank failures and business bankruptcies. A聽crisis in 1907 led to calls for an institution that would prevent panics and disruptions.

Referred to simply as the Fed, it has broad power to take measures to ensure there is financial stability in the system. It is also the main regulator of the country's financial institutions. Banks will often turn to the Fed as a last resort where they can borrow money when there is nowhere else to go.

As mentioned above, the system is made up of 12 regional Federal Banks. These are based in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

The Fed聽is considered to be independent because its decisions do not have to be ratified.

The Fed聽is considered to be independent because its decisions do not have to be ratified by the president or any other government official. However, it is still subject to Congressional oversight and must work within the framework of the government鈥檚 economic and fiscal policy objectives. Its duties can be categorized into four general areas:

  • Conducting national monetary policy by influencing monetary and credit conditions in the U.S. economy to ensure maximum employment, stable prices, and moderate long-term interest rates.
  • Supervising and regulating banking institutions to ensure the safety of the U.S. banking and financial system and to protect consumers鈥 credit rights.
  • Maintaining financial system stability and containing systemic risk.
  • Providing financial services, including a pivotal role in operating the national payments system, to depository institutions, the U.S. government, and foreign official institutions.
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Image by Sabrina Jiang 漏 Investopedia聽2020

Special Considerations

The Fed鈥檚 main income source is interest on a range of U.S. government securities it has acquired through its operations. Other income sources include interest on foreign currency investments, interest on loans to depository institutions, and fees for services鈥攕uch as check clearing and fund transfers鈥攑rovided to these institutions. After paying expenses, the Fed transfers the rest of its earnings to the U.S. Treasury.

Federal Reserve vs. Federal Open Market Committee (FOMC)

The Federal Reserve's Board of Governors is responsible to set reserve requirements. This is the amount of money banks are required to hold to ensure they have enough to meet sudden withdrawals. It also sets the discount rate, which is the interest rate the Fed charges on loans made to financial institutions and other commercial banks.

The Federal Open Market Committee (FOMC), on the other hand, is the Federal Reserve鈥檚 main monetary policymaking body. It is responsible for open market operations including the buying and selling of government securities. The FOMC includes the Board of Governors鈥攌nown as the Federal Reserve Board (FRB)鈥攖he president of the Federal Reserve Bank of New York, and the presidents of four other regional Federal Reserve Banks who serve on a rotating basis.

The committee is responsible for monetary policy decisions, which are categorized into three areas鈥攎aximizing employment, stabilizing prices, and moderating long-term interest rates. The first two are known as the Fed's dual mandate.