IntroductionThe FederalReserve System is the central banking systemof the United States.It was created on December 23, 1913, with the enactment of the Federal Reserve Act.The Federal Reserve System was established with the main objectives of settingnation’s monetary policy,supervising and regulating banking institutions, maintaining the stability ofthe 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 itregulates the largest economy of the world and its decisions and policies haveworldwide impact.
Functions of FederalReserve SystemFederal Reserve Systemperforms following key functions.1. Managing Inflation: TheFederal Reserve controls inflation bymanaging credit, the largest component of the money supply. The Fed restricts credit byraising interest rates and making credit more expensive. That reduces themoney supply, which curbs inflation. When there is no risk of inflation, theFed makes credit cheap by lowering interest rates.
Thisincreases liquidity and spursbusiness growth. That ultimately reduces unemployment.2. Supervising Banking System: TheFederal Reserve oversees roughly 5,000 bank holding companies, 850state bank members of the Federal Reserve Banking System and any foreignbanks operating in the United States. The Federal Reserve Banking System is anetwork of 12 Federal Reserve banks that both supervise and serve as banks forall the commercial banks intheir region.
The Federal Reserve sets the reserve requirement for the nation’sbanks i.e. percentage of money bank should hold under it which cannot be lent.3. Providing banking services: TheFederal Reserve provides banking services to the US government and depositoryinstitutions like savings banks, savings and loan associations and creditunions. TheReserve Banks provide the U.S. Treasury with a checking account, and when thegovernment pays for something, the payment is typically cashed by or depositedin a commercial bank.
The Fed processes the payment and deducts the amount fromthe Treasury’s account.4. Protecting Consumer interests: TheFed helps ensure that the financial institutions it supervises comply with thelaws that protect consumers. These laws govern consumer credit to help ensurethat banks and other financial institutions are acting in the public’s bestinterest. StructureStructure of FederalReserve System is often described as “Free within government”The System does notrequire 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 systemare as follows: 1. Board of Governors: The seven-member Board of Governors is afederal agency. It is charged with the overseeing of the 12 District ReserveBanks and setting national monetary policy.
It also supervises and regulatesthe U.S. banking system in general.
Governors are appointed by the Presidentof the United States and confirmed by the Senate2. Federal Open Market Committee: The Federal Open Market Committee (FOMC)consists of 12 members, seven from the Board of Governors and 5 of the regionalFederal Reserve Bank presidents. The FOMC oversees and sets policy on open marketoperations. These operations affect the amount of FederalReserve balances available to depository institutions, thereby influencingoverall monetary and credit conditions. The FOMC also controls operationsundertaken by the Federal Reserve in foreign exchange markets.3.
Federal Reserve Banks: There are 12 regional Federal Reserve Banks which serve as the operating arms of thesystem. Each regional Reserve Bank has a board of directors, whose members workwith their Reserve Bank president to provide grassroots economic information whichis used for management and monetary policy decisions.4.
Member Banks: Eachmember bank is a private bank that holds stock in one of the twelve regionalFederal Reserve banks. The amount of stock each member bank holds should be equalto 3% of its combined capital and surplus of stock. CriticismThe Federal ReserveSystem has faced various criticisms since its inception in 1913. Criticisms include transparency, doubt of efficacy due to what isseen by some as poor historical performance and traditionalist concernsabout the debasement of the value of the dollar. FederalOpen Market Committee which is part of the FederalReserve System is often criticized for lacking transparency and not beingsufficiently audited.Federal Reserve Systemis often held responsible for Global financial crisis of 2007-08. It is pointedout by critiques that the Federal Reserve kept interest rates too low followingthe 2001 recession whichcaused the United States Housing bubble which led to credit crunch.
ConclusionGoing by thehistorical data and researches it is often discovered that higher theindependence of the central banking system in the country, lower are the ratesof inflation. The generally agreed upon reason independenceleads to lower inflation is that politicians have a tendency to create too muchmoney if given the opportunity to do it, thus an independent central bankingsystem is needed to keep the economy in check and prevent it fromcrashing. The Federal Reserve System in the United States is generallyregarded as one of the more independent central banks hence it plays important role in USeconomy by managing inflation and stabilizing economy.