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The Federal Reserve System

What the Fed does and the surrounding controversy

The Federal Reserve System is the central banking system of the United States.

It was created by an act of Congress in 1913, after a bank panic in 1907

threatened to disrupt the flow of money from banks to customers. Since it was

founded, the Fed’s role has steadily expanded; it’s now one of the most

respected—and reviled—financial institutions in the world. Why? Because some

people think it’s more important than ever as a regulatory body, while others see

it as nothing more than an obstacle to economic recovery.

What is it?

The Fed is a network of 12 banks and 25 branches owned and operated by the federal government and led by a board

of governors which includes a chairman—the public “face” of the Fed. While the Federal Reserve Banks are

responsible for a variety of monetary and transaction services, the Board of Governors is responsible for regulating the

banking industry, developing policies, and defending consumer credit protections.

What does it do?

Before the Fed was created, the US government had very little to do with the banking industry. It was Congress’ hope,

as well as the goal of President Woodrow Wilson; that the Federal Reserve System would help support the US

economy, prevent banking crises, and foster nationwide employment.

Today, the Fed’s responsibilities fall into four big categories:

Monetary Policy

Monetary Policy is everything that has to do with the money in your pocket and bank account, including how much

gets printed each year, and how much interest banks can earn on their deposits at Federal Reserve Banks. The Fed

makes decisions like these to either slow down or speed up the US Economy: higher interest rates slow things down

by preventing borrowing and making exports more expensive; lower interest rates speed things up by doing the

opposite, among other things.

Regulating & Supervising Banking Institutions

The Fed also keeps an eye on banking institutions that are based in or operate in the United States to ensure that they

conduct business fairly and legally. These supervisory and regulatory responsibilities include ensuring that banks don’t

engage in overly risky practices that endanger customers’ deposits, that banks don’t break laws designed to protect

consumers from unfair policies, and to prevent a banking monopoly, where one bank acquires so many others that

consumers don’t have options to choose from.

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Economic Stability

During a national crisis, a disruption in the financial markets can lead to a banking meltdown: if banks can’t get to their

money, neither can consumers, and that could result in disastrous social, civil, and economic consequences. To

prevent that, the Fed springs into action, offering banks a “discount window” during which money can be rushed to

them to meet immediate needs. In turn, consumers would be reassured that their money was safe and available.

Financial Services

Every day, trillions of dollars flow through the US banking system: checks are cashed, funds are transferred between

banks, and deposits are made. The Federal Reserve System is at the heart of it all. The Fed functions as a giant

pipeline through which banks can route and exchange money. It also ensures there’s enough cash circulating to meet

consumer needs and back all of these transactions.

Before the Fed, banks could—and did—refuse to cash checks from competing institutions. That’s one of the reasons

the system nearly fell apart in 1907. Those concerns are a thing of the past, thanks in large part to the founding of the

Fed.

What’s the controversy about?

Today, people who oppose the Fed decry its ability to inject money into the marketplace, its control over interest rates,

and its independence from congressional and presidential oversight. Opponents of the Fed want the system

dismantled, claiming that its activities and policies are actually harming the economy in the long run.

What opponents must contend with, however, are the problems that the Fed was created to solve: who will ensure

consumers are protected from unfair banking policies? Who will decide how much money the economy needs to

support itself? Who will rescue banks that, if they fail, could destroy the financial lives of their customers? Who will

take action to prevent rapid inflation and deflation? And, lastly, who will guarantee that transactions between private

banks are conducted smoothly and legally?

The conversation about the Fed and its powers is part of a larger debate about the federal government’s role in private

businesses and the lives of citizens. It’s a debate that started almost as early as the founding of our country, and it’s

one that’s sure to continue for generations.