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A day doesn’t go by that your life isn’t affected by the Federal Reserve System.
Taking out a loan or paying a credit card bill? The Federal Reserve influences interest rates. Wondering about the economy? Its policies affect inflation rates, employment and manufacturing. Its most public presence, meanwhile, is in your wallet – every dollar is imprinted with “Federal Reserve Note.”
With all the attention given to interest rates and “the Fed,” as many refer to it, what exactly is the Federal Reserve System and what does it do?
On Dec. 23, 1913, President Woodrow Wilson signed the Federal Reserve Act that created the central bank of the United States. This came at a time when there were as many as 1,600 state banks designing and printing their own notes — an approach to decentralized banking that was ripe for financial crises.
PNC’s Chief Economist Stuart Hoffman said the Fed was created “to help minimize financial panics and other things in the financial system that had thrown the U.S. economy off kilter into recession. It provided the nation with a safer, more flexible and more stable monetary and financial system.”
The Fed is basically the bank of the U.S. government and the gatekeeper of the U.S. economy. It manages the delicate balance between national and regional interests with duties that fall into four general areas:
The Federal Reserve controls three tools of monetary policy as follows:
The Fed has the power to create money where none existed previously. If the Fed buys treasury bonds through its open market activities, Hoffman says, “it has the supernatural, man-behind-the-curtain, wizard power to create new money to pay for its treasury securities.”
He added: “On the other hand, if the Fed sells securities, it can take the money that the buyer pays for those securities and simply erase that money from the government’s balance sheet.”
Most people probably know the Fed as the issuing authority for all Federal Reserve Notes. The Fed’s Board of Governors has a wide range of responsibilities related to paper money, from ensuring an adequate supply to protecting and maintaining confidence in our currency.
Other tools for the Fed include:
Federal Open Market Committee: The FOMC is made up of the seven Fed governors and 12 presidents of the Federal Reserve District Banks from around the country.
Federal Funds Rate: This is a key driver of the interest rates you are charged for credit. This rate is set by the FOMC and the range is used by banks to lend money to one another, usually overnight. The actual rate is determined by supply and demand by individual banks.
Hoffman says, “if the Fed is adding reserves (money) to the banking system, as they have done in recent years, the action will generally push the Federal Funds Rate down.”
Interest Rate on Excess Reserves: This is interest earned on bank reserves held in the central bank over and above those needed to cover mandated reserve requirements. Currently, U.S. banks park about $2.5 trillion in reserves with the Fed. The interest on this money is paid directly to those banks.
At the core of the system is the Board of Governors, or Federal Reserve Board, which is a federal government agency. The board consists of seven members who are appointed by the president and confirmed by the Senate. A governor's full term is 14 years. Heading the Board of Governors are a chair and vice chair, who are governors whom the president appoints to serve four-year terms.
The Federal Reserve Banks are not a part of the federal government, but they exist because of an act of Congress. Their purpose is to serve the public. So is the Fed private or public?
The answer is both. While the Board of Governors is an independent government agency, the Federal Reserve Banks are set up like private corporations.
Member banks hold stock in the Federal Reserve Banks and earn dividends. Holding this stock does not carry with it the control and financial interest given to holders of common stock in for-profit organizations. The stock may not be sold or pledged as collateral for loans.
The Federal Reserve Board oversees the 12 Reserve District Banks, which are strategically located in large cities across the country. They are located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco. Each district provides a regional perspective and expert knowledge about their local economies.
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