Guide to the Federal Reserve
What does the Federal Reserve do?
When the Federal Reserve was created in 1913, the U.S. Congress established three primary objectives for its central bank: maximize employment, stabilize prices, and manage long-term interest rates. The Fed achieves these goals by providing the U.S. with a central monetary policy and regulating U.S. banks. The 12 Federal Reserve Banks act as “banks for the banks.” When the Board of Governors of the Federal Reserve changes the federal funds rate, it causes other banks to act accordingly, thereby controlling the flow of money into the economy.
What happens when the Fed raises interest rates?
When the Federal Reserve raises the federal funds rate, this immediately raises the cost of short-term borrowing for financial institutions, which is then passed on to consumers. When credit card and mortgage interest rates rise, disposable income falls, which in turn limits inflation and makes the housing market less competitive.
How does money supply affect interest rates?
The flow of money in the U.S. economy fluctuates based on the actions of the Federal Reserve. In general, more money flowing through the economy corresponds with lower interest rates, while less money available generates higher rates. The Fed is responsible for limiting inflation. By raising interest rates, it becomes more expensive to lend money, so consumers and businesses hold off on making investments thus cooling demand, which lowers prices.
What is the difference between the U.S. Treasury and the Federal Reserve?
The Federal Reserve and U.S. Treasury are separate entities. The Treasury is responsible for printing money and managing the in and outflow of U.S. currency. The Treasury also houses the U.S. supply of gold and advises the President on economic decisions. The Federal Reserve is responsible for managing the U.S. economy. The Fed, the U.S. central bank, sets interest rates, regulates the nation's private banks, and manages the money supply in order to limit inflation and maximize employment.
In a market economy, most economic decisions are made by private businesses and citizens and follow the principle of supply and demand. Though most developed nations are technically mixed economies because they allow some government interference, they are often described as market economies because they allow market forces to drive the vast majority of activities.
Federal Funds Rate
The federal funds rate is the target interest rate set by the Federal Open Market Committee (FOMC). The fed funds rate is the interest rate that banks charge to one another to borrow money. This rate can influence short-term rates on consumer loans, mortgages, and credit cards. The target fed funds rate is set eight times a year by the FOMC.
Quantitative Easing (QE)
Quantitative easing (QE) is a form of monetary policy in which central banks increase the supply of money by buying government bonds and other securities. QE helps lower interest rates and promote lending and investment.
A central bank is a financial institution responsible for overseeing the monetary policy of a nation or group of nations. Central banks regulate other banks, control the flow of money, and can provide loans to financial institutions in emergency situations.
Federal Open Market Committee (FOMC)
The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve System responsible for setting the nation’s monetary policy. The FOMC meets eight times a year to set the target federal funds rate. The committee has 12 members: the seven members of the Board of Governors of the Federal Reserve; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents.