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There's a bank that you use to deposit your checks and make purchases — and then there's the bank.
The Federal Reserve, or "the Fed," is the central bank of the U.S., and just about everything it carries out influences your financial decisions and opportunities more than you may realize.
An independent federal agency, the Fed was established in 1913 in response to a series of bank failures and stock market panics that were causing growing unease with the nation's largely unregulated financial system.
By creating a central bank, the government hoped to provide a stable yet flexible authority that could manage monetary policy, regulate its financial institutions, and instill confidence in the U.S. economy.
Here's what you need to know about the Fed, and how it affects you and your money.
The Fed's mission is the same now as it was when it was established: to serve the public interest and provide the country with a safe and stable financial system. The Fed's main responsibilities include:
By overseeing the nation's banks and influencing interest rates, the Fed impacts the economy and Americans' financial lives.
While it doesn't interact directly with individuals, the Fed ensures they can deposit a check, use a debit card, and transfer funds safely and consistently. The policies the Fed sets ultimately affect how easy or hard it is to qualify for a mortgage, the interest you'll pay on a loan, and how much money that savings account or CD will earn you.
The Fed was created after President Woodrow Wilson signed the Federal Reserve Act in December 1913. While the architects who helped create the Fed had many objectives when creating this system, one major aim was to bring greater stability to the nation's banking system.
The legislation that Wilson approved resulted in a system of regional banks, along with a Federal Reserve Board to oversee that system.
One major component of the Federal Reserve structure is the Board of Governors, which consists of seven members who need to be nominated by the president and then confirmed by the Senate to hold their seat. Members join the Board to serve a term of 14 years. The president nominates individuals for the position of Chair, as well as Vice Chair of the Board, as well as Vice Chair for Supervision, from existing board members. Anyone who lands one of these positions serves a term of four years.
The Board of Governors is responsible for certain aspects of monetary policy, namely setting reserve requirements and the discount rate. Reserve requirements basically dictate how much capital a bank must hold in terms of reserves in order to meet its liabilities.
The discount rate is the rate the Fed charges when lending money to large financial institutions.
Federal law specifies that the official heading up the Fed "shall appear before the Congress at semi-annual hearings" regarding "the efforts, activities, objectives and plans of the Board and the Federal Open Market Committee" as well as "economic developments."
The current Federal Reserve system has 12 regional Reserve Banks, which are spread across the U.S. in places like Boston, New York, Atlanta, San Francisco, and Philadelphia. These banks also have a total of 24 branches.
Each Reserve Bank has its own territory known as a Federal Reserve District, which consists of several states, and is responsible for the banks and individuals within that area. This system is decentralized by nature to help ensure that Fed officials account for communities from all over the country when formulating policy.
The graphic below shows the locations (and territories) of these Reserve Banks.
Reserve Banks basically serve as branches of the entire Federal Reserve system. Originally, they were intended to operate independently, setting their own policies and interest rates. But as the U.S. economy grew more complex and geographically integrated, new legislation in the 1930s and in 1980 made them more coordinated with each other and with their federal parent.
Today, each Federal Reserve Bank is responsible for implementing the decisions of the Fed's Board of Governors and enforcing its rules on a regional level. It's the district Federal Reserve Bank that directly oversees individual, local banks — granting their charters and inspecting their operations.
Some of the day-to-day services the Reserve Banks provide include:
While the regional banks don't set monetary policy, they do provide economic research to the national Fed — data and analysis that play a key role in the decisions made by the central bank's all-important Federal Open Market Committee.
The third and arguably most influential arm of the Federal Reserve is the Federal Open Market Committee (FOMC). Added to the Fed in the 1930s, this policy-making group is made up of 12 voting members, including all seven Fed Governors, the President of the Federal Reserve Bank of New York, and four of the 11 other Reserve Bank Presidents.
The group meets at least eight times per year and is responsible for reviewing the country's economic conditions, conducting risk assessments on economic growth, and managing the federal funds rate, a benchmark rate that has broad implications for the financial system and economic conditions.
More specifically, the federal funds rate is the interest rate at which banks can borrow and lend money to one another. Under Federal Reserve quota rules, banks are required to keep a certain percentage of overall deposits in reserve, to ensure that account holders can access their money at any time, preventing any "bank runs" or financial panic.
If an institution falls short of the requirement, it may turn to other banks for additional funding. If a bank has excess reserves, it will loan them out.
Setting the federal funds rate is arguably the most important responsibility of the Federal Reserve. Banks generally make a profit by lending money for a greater price than they obtained it.
So lowering the cost of financing for the bank has a ripple effect: The savings ultimately get passed down to the everyday consumer looking to purchase a house, take out a loan, or engage in any other financial transaction. Changes in the federal funds rate also ultimately affect how much interest bank savings accounts and CDs earn.
When the alert flashes on your phone or you hear a newscaster say, "The Fed cut interest rates today," it's a move by the FOMC they're referring to.
Past that, the FOMC is in charge of open market operations, which involves buying and/or selling securities to influence interest rates. Before the Financial Crisis, the aforementioned committee used this tool in order to influence the federal funds rate. However, after the crisis, the FOMC used open market operations in an effort to keep long-term interest rates close to zero in order to facilitate economic growth.
This system also involves a Federal Advisory Council, a body composed of 12 banking industry representatives. The aforementioned council is obligated to meet at least four times a year, according to the Federal Reserve Act, and "consults with and advises the Board on all matters within the Board's jurisdiction," according to a page on the Federal Reserve website.
One of the major functions of the Federal Reserve is controlling monetary policy, which affects the total supply and money and also interest rates. The central bank has a dual mandate, which involves promoting economic growth and keeping inflation at reasonable levels.
The Fed seeks to achieve its goals through the use of both policy levers, which were mentioned previously, and the communications of its officials, which are meant to provide a signal of how the various Fed officials view economic conditions and how they will use policy to influence those conditions going forward.
The FOMC has regular meetings and issues public statements at the conclusion of these meetings, including information on how committee members voted.
The Fed regularly assesses financial institutions to ensure they are in compliance and meet certain requirements. The assessments vary based on the scale and complexity of the institution in question.
One method the Fed uses to assess individual banks is stress tests, where it uses a hypothetical scenario to determine how well a lending institution would function at times of financial strain.
When the Fed came into existence in 1913, one of its major objectives was helping ensure financial stability. Pursuant to this goal, the central bank has monitored financial institutions for over 100 years.
However, in the aftermath of the financial crisis, U.S. lawmakers enacted the Dodd–Frank Wall Street Reform and Consumer Protection Act (also known simply as the Dodd-Frank Act), which provided the nation's central bank with greater responsibilities in terms of monitoring the entire financial system.
As a result of this, the Fed has started taking a different approach, regularly examining various sources of vulnerability and including its findings on the stability of the broader financial system in its Financial Stability Report.
As stated previously, open market operations entails the FOMC buying and/or selling assets in order to influence interest rates in an effort to achieve the central bank's objective of "maximum employment and stable prices."
Buying fixed-income assets like bonds injects money into the economy, and it places downward pressure on interest rates. Selling assets, alternatively, takes money out of the financial system and puts upward pressure on interest rates.
Instead of borrowing from one another, financial institutions can also borrow money directly from one of the regional Federal Reserve bank "windows." The rate at these windows is often higher than the federal funds rate itself and serves as the cap for the market — no bank would want to pay more money when a lower rate is available. As a result, the Federal Reserve can encourage banks to borrow from one another and can effectively limit the amount of interest charged.
The discount rate is the rate of interest that these financial institutions must pay when borrowing money from a Federal Reserve bank in this manner.
Reserve requirements dictate how much money banks need to hold in reserves so they can maintain solvency in the event that many depositors want to withdraw their money at the same time. If the Federal Reserve wants to expand the money supply, it can simply lower this requirement, so banks have more money to lend. If it wants to tighten the money supply, it can increase the requirement.
Ultimately, interest rates are a function of the demand for, and supply of, capital. In other words, it is determined by how much individuals and businesses want to borrow money compared to how much institutions want to lend it.
However, the Fed can influence interest rates using monetary policy, leveraging tools like the federal funds rate, discount rate, and open market operations to impact these rates.
There are many different variables that influence inflation. For example, a natural disaster like Hurricane Katrina can cause energy prices to soar, which in turn has widespread implications by increasing the cost of producing many different goods.
One major objective of the Fed is helping promote job creation. The central bank can use monetary policy to help bolster the labor market by increasing the money supply and lowering interest rates. A greater money supply can enhance demand, and lower interest rates may motivate individuals and businesses to take on more debt, stimulating the economy and providing the demand that contributes to employment.
What is the primary role of the Federal Reserve? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
The primary role of the Federal Reserve is to supervise monetary policy, regulate banks, and maintain financial stability. The Fed also has a mandate of promoting economic growth and stable inflation.
How does the Federal Reserve influence interest rates? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
The Federal Reserve influences interest rates in many ways. The FOMC sets the target range for the federal funds rate, and it also engages in open market operations in an effort to keep the aforementioned rate within this range. The Fed Board of Governors can also influence interest rates through the discount rate.
What is the Federal Open Market Committee (FOMC)? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
The FOMC is a Fed committee that sets the target range for the federal funds rate and engages in open market operations in an effort to keep the rate within this range.
How many Federal Reserve Banks are there? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
There are 12 regional Federal Reserve Banks in the U.S.
What are the main tools the Federal Reserve uses to conduct monetary policy? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
How does the Federal Reserve influence the economy?">The main tools the Fed uses to conduct monetary policy include open market operations, the discount rate, and reserve requirements.
Alexandra SumnerJasmine was a senior editor at Insider where she led a team at Personal Finance Insider, focusing on explainers, how-tos, and rounds-ups meant to help readers better understand personal finance, investing, and the economy. Her team tackled projects including: • Women of Means, a series about women taking control of their finances. • Better, Smarter, Faster, a series that reveals the impactful choices you can make with your money to set yourself up to pursue your passions and fulfill big life goals. • Master Your Money, a yearlong guide for millennials on how to take control of their finances. • Rethinking Retirement, an editorial collection with stories that will inspire and provide the foundation for planning a different type of future than the 9-5 life allows. • The Road to Home, a comprehensive guide to buying your first house. She also worked cross-functionally with the video team at Insider to develop and build PFI's YouTube channel. Before joining Insider, she was a senior editor at NextAdvisor, Time magazine's personal-finance brand launched in partnership with Red Ventures. Before that, she was an editor at Credit Karma.
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