What Is the Federal Reserve? And What Do They Do?

Written by Samantha CatheyUpdated: 4th Apr 2022
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The Dude. The Thing. The Joker. The Fed. They need no extra words to tout their infamy. Qualified by the definite article, there can only be one.

And three of the four mentioned here likely don’t affect your life quite like the Fed does. Who or what is the Fed? And why does it sound so ominous? Rest assured, the Fed is nothing to be afraid of.

What Is the Federal Reserve?

Otherwise known as the Federal Reserve, this independent federal agency is so important to the U.S. economy, and consequently the world, it goes simply by the Fed.

America’s central bank was created in 1913 when President Woodrow Wilson signed the Federal Reserve Act into law to combat the country’s unregulated financial system.

Established by Congress as a result of stock market panics and bank failures, the Fed provides the country with a safe and stable, yet flexible, financial and monetary system.

How Does the Federal Reserve Work?

So how does America’s most important bank work and what does it do? Its duties are different than what goes on in your average local bank, but we all are affected by its policies and procedures.

The entire Federal Reserve System is comprised of three entities: a board of governors, 12 regional reserve banks, and the Federal Open Market Committee (FOMC). We’ll explain in detail each one further on.

What Does the Federal Reserve Do?

The Fed has a series of tools to achieve its goals, the primary of which is to manage inflation. It also provides banking services, regulates, and supervises, and sets interest rates.

Overall, the Fed aims to guide monetary policy via its dual mandate: maintain maximum sustainable employment and stable prices.

Manages Inflation

Managing inflation is tied closely to setting interest rates, and these two functions of the Fed center around either contractionary or expansionary monetary policy.

The Fed tries to keep inflation at about 2%. To fight inflation and stabilize economic growth, it sells securities to banks with its contractionary policy.

To make money more accessible to consumers and to stimulate economic growth, it buys securities from banks which is expansionary policy.

Sets Interest Rates

People often read a headline or hear on a news program that the Fed is raising or lowering interest rates.

This refers to the Federal Funds rate, or the rate at which banks borrow and lend money to one another. Rates are driven up or down when the Fed participates in Open Market Operations (OMO).

The Federal Funds rate doesn’t directly affect consumers, but it does influence other interest rates like the prime rate, which is the interest rate banks typically offer their best customers.

Another facet of expansionary monetary policy is lowering interest rates which makes loans cheaper, and the opposite can be said about contractionary monetary policy where higher interest rates make borrowing more expensive.

Provides Banking Services

Known as the “banker’s bank,” the Fed maintains the Treasury Department’s accounts, as well as operates the national payments system, like clearing checks and processing electronic payments.

It supervises the 12 Federal Reserve banks and sets the reserve requirement, or the percent of deposits financial institutions need to keep on hand each night.

The Fed also regulates the amount of currency and coin in operation.

Regulates and Supervises

Broadly speaking, the Board of Governors sets banking guidelines through regulations and policy choice based on legislation.

To avoid another 2008 financial meltdown, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

This was put in place to protect consumers’ rights and keep the economy safer from hazardous lending behavior by banks and insurance companies.

What Are the 12 Banks of the Federal Reserve?

Now we know what the Fed does, but who’s behind the curtain running the show? The Federal Reserve oversees 12 regional Federal Reserve Banks, each responsible for a geographic area of the country.

They are located in San Francisco, Dallas, Kansas City, St. Louis, Minneapolis, Chicago, Atlanta, Cleveland, Richmond, Philadelphia, New York, and Boston. Each has its own president and board of directors.

What Does the Fed Chair Do? And Who Is It?

In addition to the regional banks, the Fed also has a Board of Governors. After being nominated by the President and confirmed in the Senate, the seven members serve a maximum of 14 years.

Their primary responsibility is reviewing the nation’s economy and growth while serving on the Federal Open Market Committee.

The President appoints one member of the Board of Governors to chair the entire system. The Fed Chair, currently Jerome Powell, provides leadership throughout his or her four-year term.

Alongside other members of the board, the chairperson frequently testifies before Congress and submits a comprehensive Monetary Policy Report twice a year.

Perhaps most important, the Fed chair presides over the actions of the Federal Open Market Committee which meets about every six weeks.

Who Owns the Federal Reserve?

The Federal Reserve is not owned by anyone, but member commercial banks do hold shares of the 12 regional banks.

Without voting privilege there isn’t true ownership. Note: it is imperative the Federal Reserve remains independent and safeguarded from political influence. It would not be good if fiscal policy were subjected to day-to-day politics.

Is the Federal Reserve Considered a Central Bank?

Despite being named our “central bank,” the Fed is decentralized, meaning it operates outside government control.

Broadly defined, a central bank is responsible for supervising the money system and policies of a nation.

America’s central bank is further considered independent because its decisions aren’t subject to presidential or congressional approval, though it must work within the government’s economic agenda.

Does the Fed Print Money?

The Federal Reserve is often described as “printing money” but it doesn’t literally print currency bills.

That job belongs to the Treasury Department’s Bureau of Engraving and Printing; however, the amount printed is determined by the Fed.

This phenomenon of “printing money” is the Fed increasing the supply of money, most notably done through a process called quantitative easing, which is when the central bank purchases long-term securities to motivate the economy.

It’s a somewhat controversial program most notably implemented as a response to the 2008 financial crisis.

Though critics were concerned about creating hyperinflation, The Fed bought mortgage-backed securities directly from the banks to pump money into the economy.

The Fed employed quantitative easing again to remediate the financial fallout of the coronavirus pandemic.

How the Federal Reserve Affects Every American

It is important the Federal Reserve maintains transparency and communicates the reasons for its actions.

First, the Fed chair and sometimes other board members testify before Congress. Second, the Fed submits a detailed Monetary Policy Report to Congress twice a year.

And third, the Federal Open Market Committee publishes official statements after meetings. The press analyzes these messages for clues into how our economy is functioning.

Bottom Line: What Is the Federal Reserve?

The Federal Reserve affects everyday American’s financial concerns through setting interest rates, managing inflation and protecting consumers.

The rate of your car loan. The likelihood of being laid-off. The money you can earn in a savings account. Even the value of your home.

Its all tied to the Federal Reserve, and while the Fed doesn’t have a boss, it does report to the people.

Samantha Cathey
Samantha Cathey

Samantha Cathey is a Senior Personal Finance Writer & Product Analyst with years of financial training and industry knowledge. She is a former banker, loan officer and investment advisor before dedicating her energy to helping individuals more creatively, through her writing. Samantha studied at the University of Idaho where she majored in Journalism and Writing. Her areas of expertise are mortgages, credit cards, loans, and investing.