Regardless of whether a person is trying to improve their investment skills, planning for future retirement, saving for their child’s education, or merely trying to stay employed, it is vital that they have certain financial and economic knowledge. One important knowledge component is an active awareness of their nation’s central bank. The central bank of most countries attempts to control the supply and value of their currency. Thus, central banks, throughout the world, affect the livelihood of their citizens.
United States is no exception. As a result, for a person attempting to achieve financial success, he/she cannot and should not leave their future to chance. By understanding what a central bank can do, what it does, and what that action affects, a person can better safeguard his/her employment and financial standing. So, now it begins. It begins with the basics and it ends with an awareness of what the central bank’s actions predict.
Throughout much of the world, to ensure a stable economy, a central bank is responsible for certain financial functions.
In the United States (US) the central bank is referred to as the Federal Reserve System (Fed). The Fed establishes and implements the nation’s monetary policy, strives to maintain financial stability, works toward ensuring the soundness of the nation’s financial institutions, facilitates the medium of payment system, and attempts to protect consumers through the administration of various laws and regulations. Monetary policy of the Fed seeks higher employment levels, stable interest rates, and steady prices. Stability is also sought in the exposure of the US to the various financial systems around the world. Worldwide financial interplay requires the Fed to aid the safety of US financial institutions, secure payment transactions, and protect the US consumers. It is these functions and responsibilities of the Fed that help ensure a stable economy (1).
Central banking in the US, contrary to the phrase, is not concentrated in one single bank or location. The Federal Reserve Act did establish a central governing board, but it also established 12 Reserve Banks as a decentralized operational feature. It was signed into law by President Woodrow Wilson in 1913. Through the Act, a decentralized structure was developed in response to public concern about a possible centralization of power. In 1914, 12 regional Reserve Banks opened with various procedures to serve the public on a regional basis. To serve the general public, the Federal Reserve System put in place the Board of Governors, various Reserve Banks, and later the Federal Open Market Committee (FOMC). Originally, the Fed was given a 20-year charter. But, in 1927, the McFadden Act removed this restriction, making the Fed permanent (2).
Part of this organization structure, the FOMC, and the Board of Governors was designed to gather information from the various regional Reserve Banks to enable an appropriate national policy. Under the Federal Reserve Act, the US Congress holds the Board of Governors (agency of the federal government) accountable and requires regular reports. The Board of Governors provides general guidance and oversight for the Federal Reserve System and the 12 Reserve Banks. Members of the Board of Governors are appointed by the President with the advice and consent of the Senate. The 12 Reserve Banks (plus their branches) and the Board of Governors share various responsibilities. Also, the Fed communicates regularly with the nation’s executive and legislative branches, but operates independently in making its decisions. This resulting operational system makes up the national financial support provided by the US central bank or Federal Reserve System (1).
Geographically, the Federal Reserve Act divided the US into 12 districts that acquired a separately incorporated regional Reserve Bank. The existing 1913 trade regions and other related economic issues influenced the establishment of the district boundaries and had little to do with the existing state boundaries. In the beginning, the 12 Reserve Banks were expected to operate independently of each other. This made it possible for the interest rate charged to commercial banks, when borrowing funds from a Reserve Bank (normally called the discount rate) would be different in each district. Awareness and attention to geographic differences was considered very important in formulating decisions. This, originally having the 12 Reserve Banks operate independently, was considered an appropriate monetary policy since it was designed to properly address each district’s economic needs (4). A national monetary policy was yet to be considered appropriate. With little economic activity simultaneously affecting several states or foreign countries (what is now referred to as open market operations), the need for an all encompassing national policy was not an urgent issue. But, times changed. More complexity began affecting the nation. The national economy became involved in more interstate and international trade. This complexity was the result of additional types of financial transactions, more rapid transportation, and new means of conducting business. This increase in national and international activities gradually made national operational and monetary policies a major concern (4).
Changes in monetary policy operations were necessary. While the Federal Reserve Act of 1913 gave the Fed responsibility for setting monetary policy, it did not effectively meet the needs of the more complicated economic environment. Through the 1933 and 1935 revisions to the Federal Reserve Act, the FOMC was created and gradually modified to meet the more complex needs. Tasked with achieving national economic goals required the Fed to direct the supply of money, its cost, and the availability of credit. To help with that task, the Banking Act of 1933 established the FOMC. This act gave the FOMC the responsibility of using the open market operations to achieve the national economic goals. The FOMC quickly adopted regulations covering the open market operations of the Reserve Banks. This involved the purchase and sale of securities, Federal agency obligations, and bankers’ acceptances. The Banking Act of 1933 separated deposit and investment banks and created the Federal Deposit Insurance Corporation (FDIC). In addition, the Act provided procedures for controlling the New York Federal Reserve Bank, which had exhibited tendencies to preside over the Fed, especially in the area of international operations (5).
Centralized control was given to the Board of Governors by The Banking Act of 1935 which was signed by president Franklin D. Roosevelt (1,6). This greatly reduced the amount of power previously given to the regional Reserve Banks. The Act also established the current structure of the FOMC and removed the Treasury secretary and the comptroller of currency from the Board of Governors. This Act also increased insurance of accounts to $5,000. Member banks now had to participate in FDIC (3,5,6). Other financial institutions had various insurance participation requirements (7). The Banking Act of 1935 further improved the ability of the FOMC to meet its goals and control the Reserve Bank of New York’s foreign currency transactions. In the years 1949-1951, pressures mounted for allowing the Fed to act regarding monetary policy without Treasury approval. Finally, The Accord in 1951 paved the way for the Fed to act without formal restraint (5,6). However, the 40+ years following this 1951 Accord continued to see concerns raised over controlling the Fed. Runaway inflation and high unemployment fueled these concerns. But, as Paul Volcker’s monetary policy of tightening the money supply gradually decreased inflation —and when the economy started improving after a painful delay — these concerns gradually subsided. In 1980, to improve the pricing of financial services, enable and improve financial operations, and improve the general organizational structure of Reserve Banks, the Depository Institutions Deregulation and Monetary Control Act was passed (5,8,9).
The Great Recession (2008-2009) again raised concerns over the Fed’s ability to properly control the economy. In 2011, the Dodd-Frank law provided for the General Accountability Office to audit emergency programs and governance structure under the Fed’s control (5). But, as a result, despite economic setbacks and political upheavals, the Fed today is better organized to achieve its goals. The Reserve Banks are independently incorporated with a nine-member board of directors. Six of these directors are elected by the commercial banks who have become members of the Fed by holding stock in their respective District Reserve Bank. The remaining three directors are appointed by the Board of Governors. At the same time, many Reserve Banks have branches. Every branch has a board of directors that is selected by either the Board of Governors or the Reserve Bank. The directors come from the private sector. Their private sector awareness and experiences bring important information, expertise, and economic insight to their particular Federal Reserve District. At the same time, many Reserve Banks have branches. Every branch has a board of directors that is selected by either the Board of Governors or the Reserve Bank. The directors come from the private sector and their experiences bring to their particular Federal Reserve District important information, expertise, and economic insight. These organizational features enable the Fed to acquire important information from local commercial banks, the district’s private sector, and improve their overall efforts at meeting national goals (7,9).
Who pays for all of this? Funding for the Fed comes from its own investments. No money is allocated to the Fed by Congress. The Fed acquires various securities through its open market operations and earns interest from these securities. In addition, fees are earned from various services such as clearinghouse operations, funds transfers, and check clearing.
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