Federal Reserve System (FRS)

What Is the Federal Reserve System (FRS)?

The Federal Reserve System (FRS), often called simply 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.

A central bank is a financial institution given privileged control over the production and distribution of money and credit for a nation or a group of nations. In modern economies, the central bank is usually responsible for the formulation of monetary policy and the regulation of member banks.

The Fed is composed of 12 regional Federal Reserve Banks that are each responsible for a specific geographic area of the U.S.

Understanding the Federal Reserve System

The Fed was established by the Federal Reserve Act, which was signed by President Woodrow Wilson on Dec. 23, 1913, in response to the financial panic of 1907. Before that, the U.S. was the only major financial power without a central bank. 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 crisis in 1907 led to calls for an institution that would prevent panics and disruptions.

The Fed has broad power to act to ensure financial stability, and it is the primary regulator of banks that are members of the Federal Reserve System. It acts as the lender of last resort to member institutions that have no other place from which to borrow. Often referred to simply as the Fed, it has a mandate 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 for borrowing money when there is nowhere else to go.

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.

Fed System Banks.

The Fed's Mandate and Duties

The monetary policy goals of the Federal Reserve are twofold: to foster economic conditions that achieve 1) stable prices and 2) maximum sustainable employment.

The Fed's duties can be further categorized into four general areas:

1. 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.
2. Supervising and regulating banking institutions to ensure the safety of the U.S. banking and financial system and to protect consumers’ credit rights.
3. Maintaining financial system stability and containing systemic risk.
4. Providing financial services, including a pivotal role in operating the national payments system, depository institutions, the U.S. government, and foreign official institutions.

Image by Sabrina Jiang © Investopedia 2020

Fed Organizational Structure

There are seven members of the Board of Governors who are nominated by the president and approved by the U.S. Senate. Each governor serves a maximum of 14 years, and each governor's appointment is staggered by two years to limit the power of the president. In addition, the law dictates that appointments represent all broad sectors of the U.S. economy.

In addition, each of the 12 regional banks has its own president.

Fed Governors (as of June 2021)

Jerome H. Powell (Chair)

Richard H. Clarida (Vice Chair)

Randal K. Quarles (Vice Chair for Supervision)

Michelle W. Bowman

Lael Brainard

Christopher J. Waller

(Seat Currently Empty)

Source: Federal Reserve.

Fed Regional Bank Presidents (as of June 2021)

Name of President

Bank Location-District

Eric S. Rosengren

John C. Williams

Patrick T. Harker

Philadelphia-3

Loretta J. Mester

Cleveland-4

Thomas I. Barkin

Raphael W. Bostic

Charles L. Evans

James Bullard

St. Louis-8

Neel Kashkari

Minneapolis-9

Esther L. George

Kansas City-10

Robert S. Kaplan

Mary C. Daly

San Francisco-12

Source: Federal Reserve.

Fed Independence

Central bank independence refers to the question of whether the overseers of monetary policy should be completely disconnected from the realm of government. Those favoring independence recognize the influence of politics in promoting monetary policy that can favor reelection in the near term but cause lasting economic damage down the road. Critics of independence say that the central bank and government must be tightly coordinated in their economic policy and that central banks must have regulatory oversight.

The Fed is also 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’s economic and fiscal policy objectives.

Fears over the expansion of the Federal Reserve balance sheet and risky bailouts for firms such as American International Group, Inc. (AIG) have led to demands for increased transparency and accountability. Recent calls in Washington to "audit" the Federal Reserve could potentially undermine the independent status of the U.S. central bank.

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

Special Considerations

The Fed’s main income source is interest charges on a range of U.S. government securities it has acquired through its open market operations (OMO). Other income sources include interest on foreign currency investments, interest on loans to depository institutions, and fees for services — such as check clearing and fund transfers — provided to these institutions. After paying expenses, the Fed transfers the rest of its earnings to the U.S. Treasury.

The Federal Reserve payments system, commonly known as the Fedwire, moves trillions of dollars daily between banks throughout the U.S. Transactions are for same-day settlement. In the aftermath of the 2008 financial crisis, the Fed has paid increased attention to the risk created by the time lag between when payments are made early in the day and when they are settled and reconciled. Large financial institutions are being pressured by the Fed to improve real-time monitoring of payments and credit risk, which has been available only on an end-of-day basis.

Federal Reserve vs. Federal Open Market Committee (FOMC)

The Federal Reserve's Board of Governors is responsible for setting 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’s 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 — known as the Federal Reserve Board (FRB) — the 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 — maximizing employment, stabilizing prices, and moderating long-term interest rates. The first two are known as the Fed's dual mandate.

Frequently Asked Questions

What does it mean that the Federal Reserve is a central bank?

A central bank is a financial institution that is responsible for overseeing the monetary system and policy of a nation. A central bank regulates the money supply and sets a nation's interest rates. Central banks also enact monetary policy. By easing or tightening the money supply and availability of credit, central banks seek to keep a nation's economy on an even keel.

Who owns the Federal Reserve?

The Federal Reserve System is not “owned” by anyone. It was created in 1913 by the Federal Reserve Act to serve as the nation’s central bank. The Board of Governors is an agency of the federal government and reports to and is directly accountable to Congress.

Does the Fed print U.S. money?

While the U.S. Treasury Department issues coins, the Fed prints and manages paper money (known technically as Federal Reserve notes). The Federal Reserve currently issues $1, $2, $5, $10, $20, $50, and $100 notes. The largest-denomination Federal Reserve note ever issued for public circulation was the $10,000 note.

How does the Fed set interest rates?

The Fed has an implicit target rate of inflation of 2%. The principle of inflation targeting is based on the belief that long-term economic growth is best achieved by maintaining price stability, and price stability is achieved by controlling inflation. Inflation levels of 1% to 2% per year are generally considered acceptable, while inflation rates greater than 3% represent a dangerous zone that could cause the currency to become devalued. The Taylor rule is an econometric model that says the Federal Reserve should raise interest rates when inflation or GDP growth rates are higher than desired.

Does the Fed collect taxes?

No. The Fed is responsible only for monetary policy and banking system oversight. Federal taxes are approved and collected exclusively by Congress (via the Internal Revenue Service (IRS) — a federal agency), which is an instance of fiscal policy. State and local taxes are collected by individual states or municipalities.