Reserve System is the central banking system
of 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 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
Federal Reserve System
performs following key functions.
1. Managing Inflation: The
Federal Reserve controls inflation by
managing credit, the largest component of the money supply. The Fed restricts credit by
raising interest rates and making credit more expensive. That reduces the
money supply, 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. That ultimately reduces unemployment.
2. Supervising Banking System: The
Federal Reserve oversees roughly 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 is a
network of 12 Federal Reserve banks that both supervise and serve as banks for
all the commercial banks in
their region. 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.
3. Providing banking services: The
Federal Reserve provides banking services to the US government and depository
institutions like savings banks, savings and loan associations and credit
Reserve Banks provide the U.S. Treasury 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 Treasury’s account.
4. Protecting 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 public’s best
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:
1. Board 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 exchange markets.
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 include transparency, 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
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.