Often referred to as ‘The Fed’, the Federal Reserve System is a central banking system for the United States of America. This system is over 100 years old, and was initially created in 1913. Today, the Federal Reserve has clear and concise goals that influence money and credit conditions throughout the country.
History of the Federal Bank
This system was born in December of 1913. Congress established this system to serve as the central bank for the United States after previous banking systems failed. Panic, bank failures and limited credit presented challenges for Americans in the decades leading up to the creation of the Fed.
The Federal Reserve was developed to create a more stable economic climate for the United States. In short, this bank’s responsibility was to oversee the monetary policy for the country.
What Is Their Purpose?
In today’s age, the purpose of the Federal Reserve hasn’t changed a great deal. It’s primary function can be categorized into the following sections:
- Overseeing and conducting monetary policy for the United States
- Regulating banks and influential financial instructions to ensure they are protecting the credit rights of consumers
- Achieve and maintain financial stability and controlling systemic risk in financial markets
- Lastly, it provides financial services to the government
Who “Owns” The Federal Reserve?
The Federal Reserve is not a private or publicly traded company. No one “owns” the Federal Reserve. The Federal Reserve reports directly to congress. The Federal Reserve has a Chairperson. Moreover, each Chairperson serves 4-year terms.
What Institutions Does the Fed Supervise?
On a high level, the Federal Reserve supervises financial institutions. They want to ensure there is safety and stability in the banking system, the financial markets the banking system influences, and ensures all laws are being followed.
What Does the Federal Reserve Do?
Understanding exactly what the Fed does, and how that impacts everyday life for Americans is complex. As mentioned above, there are 4 primary functions, but each function has numerous layers and functions.
Monetary policy is the action a central bank (the Fed), takes to achieve various macroeconomic goals. The United States wants our economy to grow at a healthy rate overtime. However, too much growth can be bad for a country, and not enough growth can be devastating on a nation. One of the ways the federal government influences monetary policy is through the discount rate. This is what the federal government charges banks to borrow money.
If the government is looking to encourage consumer spending and economic growth, they will typically lower the discount rate. Therefore the banks will charge a lower interest rate to the consumers, and more money will be spent and borrowed. If growth is occurring too quickly, the Fed will raise the discount rate.
Overlooking Financial Institutions
A country’s central bank will establish a reserve ratio all financial institutions must obey. In the United States, the Fed influences this reserve ratio, or reserve requirement. Simply put, this ratio determines how much money, in cash, a bank must keep on hand at all times instead of lending it out or investing.
The lower the reserve requirement is, the more money a bank can lend out or invest, which will increase the money supply within the country. For example, imagine the reserve requirement is 20%. If a bank has $100, they can only lend our or invest $80.
If the ratio drops to 10%, the bank can invest or loan $90. This ratio is dynamic and changes with various economic conditions.
Liaison between the Government and Financial Institutions
One of the primary functions of the federal reserve is to function as a liaison between the government and private/public financial institutions, including depository institutions. Additionally, any wrong doing on the banking end can have a catastrophic impact on the US economy.
For example, following the housing market crash of 2007 – 2009, the Federal Reserve has established and enforced more strict financial lending practices for traditional banks. Therefore, this ultimately protects the American people and economy from such tragedy occurring again.
What Is the Difference Between the Central Bank, US Treasury, and the Federal Reserve?
Let’s dive into how the central bank differs from the US treasury.
The Federal Reserve is also the central bank. Many nations have a central banking system, and in the United States, we have various names for it. There is no difference between the US Central Bank, the Fed, or the Federal Reserve. Oftentimes, when one is just starting to understand finance on a deeper level, and listens to various financial news/television, it can be a bit confusing hearing numerous people use different words for the same thing. However, these words are interchangeable.
On the other hand, the US Treasury is not the same thing as the central bank. The United States Treasury is responsible for printing money, and for offering economic advice to the President of the United States. Whereas the federal reserve oversees laws, the safety of lending, and controls the discount rate.
Dispelling Myths: Is Your Social Security Number Linked to a Federal Reserve Account?
Despite what you may have heard, your social security number is not linked to a Federal Reserve Account. The Fed is not a traditional bank where customers can deposit or withdraw money. In short, it serves as a governing agency.
Influence of the Fed
All in all, the Federal Reserve influences a great deal of our everyday finances. Between auditing and governing the banks, and influencing the discount rate, the Federal Reserve has brought stability to the US economy and banking practices.
Working with a financial advisor is a great way to ensure you hit your financial goals. Professional financial advisors will help make sense of the various terms used in the financial world, and will take a hard look at your current financial situation. Moreover, they’ll unpack your goals and help create a road map for success.