What Does the Federal Reserve Do?

From above of dollar bills in opened black envelope placed on stack of United states cash money as concept of personal income

 

You’ve likely heard about the Federal Reserve on news reports and in conversations about finances with friends, colleagues, or advisors. That being said, if you feel like you don’t have a good enough grasp on what the Federal Reserve does and how it affects you on a day-to-day basis, then this article is for you.

What Is the Federal Reserve and How Was It Formed? 

The Federal Reserve System (FRS) is often considered to be the most powerful financial institution in the world. The FRS acts as the central bank of the United States of America, and its function is to provide the country with a stable and secure financial and monetary system. 

It is ruled over by the Federal Reserve Board (FRB), which is a non-governmental agency. As the central bank, the Federal Reserve sets interest rates, manages the country’s money supply, and formulates monetary policies and regulations in order to direct the U.S. financial system. In the U.S., the FRS has 12 regional Federal Reserve Banks responsible for a specific area of the country.

How Was the FRS Formed? 

The Federal Reserve was established in 1913 after President Woodrow Wilson signed the Federal Reserve Act. This was done in response to the financial panic that had occurred in 1907 when the New York Stock Exchange was reduced to almost 50% of its peak from the previous year. 

Prior to the creation of the FRS, the U.S. was the only major financial player in the world without a central bank and had been relying on wealthy Wall Street financiers like J.P. Morgan to bail the country out of economic crises.

How Does the Federal Reserve Affect Your Daily Life? 

In addition to its responsibility as a direct supervisor of all member banks and setting monetary regulations, the Federal Reserve also has control over the federal funds rate. This determines the interest rate at which banks and other financial institutions can lend money to one another, and it can impact several things for the everyday citizen.

Whenever the FRS increases the federal funds rate in normal circumstances and with stable economic conditions, this essentially makes money more “expensive” and increases interest rates and the cost of credit. This often makes the U.S. dollar “stronger”. When the rate is decreased, it increases the money supply, often making the dollar “weaker”. 

The Federal Reserve often adjusts the rates depending on the current needs of the economy. If it’s growing too quickly and there’s a high chance for inflation, the FRS might increase the fed funds rate. However, when the economy is struggling and a recession might occur, the FRS might lower the fed funds rate to nurture economic growth. 

One of the main purposes of the Federal Reserve is to apply a monetary policy in times of need so that it can lead the economy to maximum employment and stable market prices. For example, during the financial crisis of 2008, the FRS attempted to ameliorate the economic downturn by lowering the fed funds rate to about 0% to 0.25%.

Takeaway

The primary function of the Federal Reserve and its auxiliaries is to create a secure and stable economic environment within the United States. It attempts to achieve this by supervising and regulating banks, applying appropriate monetary policy according to the current economic situation, and managing the U.S. money supply. 

You might see the effects of the FRS in your daily life reflected in interest rates on loans and credit, mortgage rates, your access to loans, your returns on bonds, and even the value of the money in your pocket or your ability to get a job, as the FRS’s decisions can affect the economy, which affects employment rates.

Please feel free to reach out to me on this or any of your investment needs or questions. I may not always have the answers at my fingertips,  but I promise I will get them for you.   Michael Torrence 

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