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Economy 101: Federal Reserve

Federal Reserve System

The central bank of a nation serves as its main financial institution. It manages the country's finances and is in charge of its monetary policy. In the United States, that entity is the Federal Reserve System. The Federal Reserve was established by Congress in 1913 and is comprised of three primary components:

  • The twelve regional Federal Reserve Banks
  • The Board of Governors
  • The Federal Open Market Committee

Federal Reserve Banks

The twelve Federal Reserve Banks are located around the country, one in each of twelve federal reserve districts. The district lines were drawn in 1913 based upon the populations of the regions at that time. Since then, branches have been added to accomodate for the changing needs of the district. For instance, the district served by the Federal Reserve Bank of San Francisco has grown dramatically since 1913 and now has four branches - in Seattle, Portland, Salt Lake City, and Los Angeles.

The primary function of the Federal Reserve System is to maintain the nation's monetary policy by influencing the amount of money in the economy. Five of the twelve Reserve Banks' presidents serve as members of the Federal Open Market Committee (FOMC) along with the seven members of the Board of Governors. It is this twelve-member committee that is responsible for governing open market operations, the buying and selling of government securities, which is the Fed's primary tool for influencing the money supply.

The reserve banks also hold the cash reserves of commercial member banks in their districts; they supervise and regulate the operations of these member banks, and provide loans to them in times of need. The banks also provide for financial services required by the U.S. government.

The Board of Governors

The Board of Governors of the Federal Reserve System consists of seven members appointed by the President to serve fourteen-year terms of office. The Board of Governors sets the discount and federal funds rate policies and the reserve requirements placed upon member banks, all of which are monetary policy instruments used to control the amount of money in the economy. Furthermore, seven of these board members make up the majority of the twelve member Federal Open Market Committee, which gives them even more responsibility for monetary policy.

The Board of Governors also plays a supervisory role over the commercial banks that are members of the Federal Reserve System, as well as a variety of other banking companies and facilities in the U.S. The current chairman of the Board of Governors is Ben Bernanke, who succeeded Alan Greenspan in 2006.

The Federal Open Market Committee (FOMC)

As already mentioned, the FOMC is composed of the seven members of the Board of Governors plus five Federal Reserve Bank presidents. The Federal Reserve Bank presidents serve on the committee for rotating one-year terms, except for the president of the Federal Reserve Bank of New York, who serves on a continuous basis.

The FOMC is responsible for the buying and selling of government securities on the open market, which is the primary method by which the Fed conducts monetary policy. Through open market operations the FOMC can increase or decrease the amount of money in the nation's economy and thus meet its monetary policy goals.

Since 1981, the FOMC has held eight regularly scheduled meetings each year in Washington, DC where members review and discuss reports on previous and prospecive economic developments and make reccomendations for monetary policy, a topic we will discuss in more depth next week.

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