Definition
The Federal Reserve System (FED) is the central banking system of the United States, established by the Federal Reserve Act of 1913. Its primary purposes are to regulate the nation’s monetary policy, maintain financial system stability, provide banking services to depository institutions, and supervise and regulate financial institutions. The system comprises 12 regional Federal Reserve Banks, their 25 branches, and all national and state banks that are members of the system. National banks are required to hold stock in their regional Federal Reserve Banks.
Main Functions
- Regulate National Money Supply: The FED controls monetary policy primarily through open market operations, the discount rate, and reserve requirements.
- Set Reserve Requirements: The FED determines the fraction of deposits that member banks must hold in reserve and not lend out.
- Supervise the Printing of Currency: It oversees the Bureau of Engraving and Printing in producing currency.
- Clearinghouse Functions: Acts as a clearinghouse for the transfer and settlement of funds between banks.
- Examine Member Banks: Ensures member banks comply with federal regulations to maintain financial system stability.
Examples
- Regulating Interest Rates: The FED determines the federal funds rate, influencing the economy by encouraging or discouraging borrowing and spending.
- Quantitative Easing: In response to economic crises, the FED may purchase large amounts of securities to inject liquidity into the economy.
- Bank Supervision: The FED conducts regular audits and inspections to ensure banks are following regulations designed to promote a stable financial system.
Frequently Asked Questions
1. How does the Federal Reserve control inflation?
- The FED controls inflation by adjusting the federal funds rate, influencing borrowing costs, and by using open market operations to control the money supply.
2. What is the Federal Open Market Committee (FOMC)?
- The FOMC is a component of the Federal Reserve System responsible for overseeing open market operations and setting monetary policy.
3. Is the Federal Reserve part of the government?
- The FED is an independent entity within the government. It operates independently of direct political influence but is subject to congressional oversight.
Related Terms
Federal Reserve Bank: One of the 12 regional banks in the Federal Reserve System that conducts day-to-day operations.
Monetary Policy: Actions of a central bank, like the FED, to control the money supply and achieve macroeconomic goals.
Reserve Requirements: The amount of funds that a depository institution must hold in reserve against specified deposit liabilities.
Clearinghouse: An intermediary between buyers and sellers of financial instruments, ensuring the smooth transfer and settlement of transactions.
Online References
- Federal Reserve System on Federal Reserve’s Official Website
- Investopedia: Federal Reserve System
- Wikipedia: Federal Reserve System
Suggested Books for Further Studies
- “The Federal Reserve System: Purposes & Functions” by Board of Governors of the Federal Reserve System
- “Secrets of the Temple: How the Federal Reserve Runs the Country” by William Greider
- “The Creature from Jekyll Island: A Second Look at the Federal Reserve” by G. Edward Griffin
- “The Courage to Act: A Memoir of a Crisis and Its Aftermath” by Ben S. Bernanke
Fundamentals of the Federal Reserve System: Economics Basics Quiz
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