Federal Reserve System is
the central banking system of the United States of America. It was established with
the enactment of the Federal Reserve Act on December 23, 1913. The Federal Reserve System
was established with the main objectives of setting nation’s monetary policy,
supervising and regulating banking institutions, maintaining the stability of
the financial system and providing financial services to depository institutions,
the U.S. government and foreign official institutions.
The Federal Reserve is the most powerful central bank in the world as it
regulates the largest economy of the world and its decisions and policies have
Functions of Federal Reserve System
Federal Reserve System performs
following key functions.
Inflation: The Federal Reserve checks inflation by controlling the largest component of
the money supply i.e. credit. The Fed restricts credit by raising
interest rates and making credit more
expensive. That reduces the money supply in the market, which curbs inflation.
When there is no risk of inflation, the Fed makes credit cheap by lowering interest rates. This increases liquidity and spurs business growth.
Banking System: The Federal Reserve manages around 5,000 bank holding companies, 850 state bank members of the Federal
Reserve Banking System and any foreign banks operating in the United States.
The Federal Reserve Banking System consists of 12 regional Federal Reserve
banks that both supervise and serve as banks for all the commercial banks in their respective regions. The Federal
Reserve sets the reserve
requirement for the nation’s banks i.e. percentage of money
bank should hold under it which cannot be lent out.
banking services: The Federal Reserve provides banking services to the US
government and depository institutions like savings banks, savings and loan
associations and credit unions. The Reserve Banks acts as a banker
to U.S. Treasury by providing it with a checking account, and when the government
pays for something, the payment is typically cashed by or deposited in a
commercial bank. The Fed processes the payment and deducts the amount from the
Consumer interests: The Fed helps ensure that the financial institutions
it supervises comply with the laws that protect consumers. These laws govern
consumer credit to help ensure that banks and other financial institutions are
acting in the consumer’s best interest.
Structure of Federal Reserve System
is often described as “Free within government”
The System does not require public
funding, and derives its authority and purpose from the Federal Reserve Act, which was passed by
Congress in 1913.The four key component of federal system are as follows:
of Governors: The seven-member Board of Governors is a federal agency. It is
charged with the overseeing of the 12 District Reserve Banks and setting
national monetary policy. It also supervises and regulates the U.S. banking
system in general. Governors are appointed by the President of the United States and
confirmed by the Senate
2. Federal Open Market
Committee: The Federal Open Market Committee (FOMC) consists of 12 members,
seven from the Board of Governors and 5 of the regional Federal Reserve Bank
presidents. The FOMC oversees and sets policy on open market operations. These operations
affect the amount of Federal Reserve balances available to depository
institutions, thereby influencing overall monetary and credit conditions. The
FOMC also controls operations undertaken by the Federal Reserve in foreign
3. Federal Reserve Banks: There are 12
regional Federal Reserve Banks which serve as the operating arms of the
system. Each regional Reserve Bank has a board of directors, whose members work
with their Reserve Bank president to provide grassroots economic information which
is used for management and monetary policy decisions.
4. Member Banks: Each member bank is
a private bank that holds stock in one of the twelve regional Federal Reserve
banks. The amount of stock each member bank holds should be equal to 3% of its
combined capital and surplus of stock.
The Federal Reserve System has
faced various criticisms since its inception in 1913. Criticisms
doubt of efficacy due to what is seen by some as poor historical
performance and traditionalist concerns about the debasement of the value
of the dollar. Federal Open Market Committee which
is part of the Federal Reserve System is often criticized for lacking
transparency and not being sufficiently audited.
Federal Reserve System is often
held responsible for Global financial crisis of 2007-08. It is pointed out by
critiques that the Federal Reserve kept interest rates too low following
the 2001 recession which
caused the United States Housing bubble which led to credit crunch.
Going by the historical data and
researches it is often discovered that higher the independence of the central
banking system in the country, lower are the rates of inflation. The
generally agreed upon reason independence leads to lower inflation is that
politicians have a tendency to create too much money if given the opportunity
to do it, thus an independent central banking system is needed to keep the
economy in check and prevent it from crashing. The Federal Reserve System
in the United States is generally regarded as one of the more independent central
banks hence it plays important role in US economy by managing inflation
and stabilizing economy.