We’ve all heard of the Federal Reserve System but many of us don’t know much about it. The media mentions the Fed every now and then, especially after it’s had one of its meetings. But what exactly does the Federal Reserve do and how does it affect us? Let’s take a look at a few of its key responsibilities and how its decisions affect the nation’s cash flow.
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What Is the Federal Reserve?
The Federal Reserve is the United States’ central banking system. It was introduced in December 1913 when the Federal Reserve Act went into effect. Unlike the central banks from the 18th and 19th centuries that were controlled by bankers, the Fed is a decentralized system that establishes some middle ground between private banks and the public.
Today, the Fed manages our monetary policy. Some of its duties include regulating U.S. banks and keeping our economy stable.
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The Federal Reserve’s Primary Responsibilities
The Federal Reserve tries to keep the country’s finances in tip-top shape. While too much economic growth can cause inflation, too little economic growth can leave the country in a financial slump. It’s up to the Fed to find a happy medium between the two extremes.
One way that the Fed maintains control over the money supply is by buying and selling U.S. Treasury bonds. It buys bonds when it needs to increase the money supply and lower interest rates. Conversely, the Fed sells bonds when it wants to reduce the money supply and raise interest rates.
Because the Fed controls our nation’s interest rates, its decisions can affect how expensive borrowing money will be. A federal funds rate hike could make things like getting a car loan or a mortgage more expensive.
How is this so? When the Fed buys bonds, it ends up with excess reserves. Banks can’t earn any interest on this extra money, so they lend it out to other banks. More money available for lending makes borrowing cheaper for everyone. A larger money supply hurts savers, however, who could see the interest rates attached to their savings accounts decline.
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How Is the Federal Reserve Structured?
The Federal Reserve System has lots of moving parts. For example, there’s the Federal Reserve Board of Governors and the 12 regional banks that have 25 branches.
The Federal Open Market Committee (FOMC) is also an important part of the Federal Reserve System. The FOMC meets eight times throughout the year to evaluate the country’s finances and make any necessary adjustments to interest rates.
Congress oversees what the Fed does. Within the Federal Reserve System, its boards of directors and auditors ensure that the Fed is meeting standards and carrying out its tasks properly.
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