Federal Reserve (the Fed)

The Federal Reserve System, usually shortened to "the Fed", is the central bank of the United States, created by Congress in 1913. It conducts monetary policy, supervises and regulates banks, maintains financial stability and provides payment services. Because the U.S. dollar anchors global finance, the Fed's decisions move markets far beyond America.

Key takeaways

• The Fed's policy goals are set by law: maximum employment and stable prices, known as the dual mandate.
• The Federal Open Market Committee (FOMC) sets the target for the federal funds rate, the benchmark for short-term interest rates.
• Higher policy rates make borrowing more expensive across the economy; lower rates do the opposite.
• The Fed is independent within government: it operates within a mandate from Congress but its policy votes are not subject to White House approval.

How the Fed steers interest rates

The FOMC meets roughly every six weeks and sets a target range for the federal funds rate, the rate at which banks lend reserves to each other overnight. That rate ripples outward into mortgage rates, corporate borrowing costs, savings yields and the pricing of bonds. Since 2008 the Fed has also used large-scale asset purchases, described under quantitative easing, to influence longer-term rates when the policy rate alone was insufficient.

The dual mandate in practice

When inflation runs above the Fed's 2% objective, the FOMC typically raises rates to cool demand. When unemployment rises and the economy weakens toward a recession, it typically cuts. The two goals can conflict, which is why Fed meetings, statements and the chair's press conferences are parsed word by word by investors worldwide.

Structure

The system has three layers: the Board of Governors in Washington (seven members appointed by the President and confirmed by the Senate), twelve regional Reserve Banks, and the FOMC that combines both. Profits are remitted to the U.S. Treasury; the Fed funds itself and does not receive congressional appropriations.

Frequently asked questions

Does the Fed print money?

Physical currency is printed by the Treasury's Bureau of Engraving and Printing. The Fed creates bank reserves electronically when it buys securities, which is what people usually mean by the phrase.

Why do other countries care about the Fed?

Much of world trade and debt is denominated in dollars. When the Fed raises rates, dollar borrowing costs rise globally and capital flows shift, which affects currencies and markets everywhere.

Sources

• Federal Reserve, About the Fed
• Federal Reserve, Monetary policy: what are its goals and how does it work?
• Federal Reserve Bank of St. Louis, In Plain English: making sense of the Federal Reserve