Federal Reserve: Definition, Creation, and Functions

The United States government is made up of several institutions that are designed to support and protect the American people. One institution that protects the monetary interests of Americans is the Federal Reserve, also known as the Fed.

The Federal Reserve is the central bank of the United States. It performs several functions to keep the economy stable and ensure a prosperous country. The Fed is managed by a Board of Governors who oversee its operations.

Learn more about what the Federal Reserve does, when it was established, and the role it plays in economic policy. This can give you a clearer picture of how the country is run.

What Does the Federal Reserve Do?

The Federal Reserve supports the American people by performing five core functions. The Fed’s responsibilities include:

• Conducting monetary policy: The Fed works to promote policies that support employment and keep prices stable.
• Mitigating risks: The Fed strives to maintain stability in the financial system through risk monitoring and mitigation. A process like quantitative easing to increase available liquid funds is a strong example of this.
• Protecting financial institutions: This, in turn, protects the money of individuals and businesses in the United States.
• Fostering payment and settling systems: The Fed manages the federal funds rate, which is the cost of government institutions to borrow money.
• Promoting consumer protections: This ensures the private funds of American consumers are safe.

The main focus of the Federal Reserve is to promote economic stability in America’s financial institutions. This also builds trust in the American public that its banks will not fail.

What Is the Federal Reserve Act?

The Federal Reserve Act was passed to establish the creation of a central bank. One of the key tenets of the act is to “establish a more effective supervision of banking in the United States.” Essentially, if there is a period of economic instability or outright financial crisis, the members of the Federal Reserve would take steps to fix the core issues. Today, the Fed still intervenes in times of financial instability and tracks macroeconomic trends.

When Was the Federal Reserve Created?

The Federal Reserve Act was passed in 1913 and signed into law by President Woodrow Wilson. It was created in direct response to The Panic of 1907 when the stock market crashed and banks across the country failed. The Panic of 1907 is one of the most notable financial crises in American history, but it is often overlooked because of the Great Depression.

Politicians had been advocating for and against the creation of the Federal Reserve for years leading up to 1907, but the financial crisis pushed Congress in favor of establishing this institution. During this crisis, the government was unable to save itself and relied on funding from private banks to reestablish stability. The creation of the Fed would allow the government to intervene and stabilize the economy if similar crashes ever happened again.

Who Started the Federal Reserve?

President Woodrow Wilson was adamant about passing currency reform even before he was elected to his position. After his inauguration in March 1913, Wilson urged Congress to develop solutions to prevent future crises like the Panic of 1907.

In March 1913, the Senate created the first Banking and Currency Committee. Its counterpart was the House Banking Committee. In June 1913, Wilson proposed the creation of the Federal Reserve, and bills to create this institution were working their way through the committees and to the House and Senate floors.

The votes to establish the Federal Reserve were split down party lines. Every Democrat present voted in favor of the measure, while most Republicans voted against it. The bill was signed by President Wilson on December 23, 1913. The establishment of the Federal Reserve is still one of the most notable and lasting achievements of Wilson’s presidency.

Who Owns the Federal Reserve?

The Federal Reserve is run by the Board of Governors based in Washington, D.C. There are seven governors, each of which is nominated by the President of the United States and confirmed by the United States Senate. Each board member serves 14-year terms and nominations are staggered. This means a single President will not be able to fill the board with members that reflect their specific financial beliefs. This process ensures the Board of Governors is objective in its monetary policies.

The Federal Reserve is part of the government and not privately owned. It answers to Congress. This ensures the Fed acts in the best interest of the American people.

The Structure of the Federal Reserve System

The Federal Reserve is often discussed as a single entity, but there are multiple moving pieces to this bank. Here is the structure of the Federal Reserve:

• The Board of Governors runs the Federal Reserve and reports to Congress.
• The 12 Districts, and 12 Reserve Banks, operate within their geographic area.
• The Federal Open Market Committee (FOMC) is an oversight committee that sets monetary policy in the United States. It has 12 members.

Each arm of the Federal Reserve has distinct roles. For example, the Board of Governors sits on the FOMC along with the president of the Federal Reserve Bank of New York and four other district bank presidents who rotate annually.

How Many Federal Reserve Districts Are There?

While the Federal Reserve is the central bank of the United States, it has 12 districts that evenly distribute funds across the country. The goal of these districts is to ensure every region of the country would have equal access to funds if there was a run on the banks or needed economic support.

The districts reflect the state of America in 1913. The populations of states like California, Oregon, and Washington were much lower than they are today. Some states, like Alaska and Hawaii, had yet to join the union when these districts were established. The districts were designed to reflect American population distribution at the time, which is why they are smaller around the East Coast.

Here are the 12 districts, named after their city’s Federal Reserve bank location:

• Boston;
• New York;
• Philadelphia;
• Cleveland;
• Richmond;
• Atlanta;
• St. Louis;
• Chicago;
• Minneapolis;
• Kansas City;
• Dallas;
• San Francisco.

New York only represents the state of New York, but the Atlanta bank represents six different states in the American South. The San Francisco bank represents the entire West Coast plus Idaho, Arizona, Nevada, Utah, Alaska, and Hawaii. It has, by far, the biggest population.

What Is the Federal Reserve’s Dual Mandate?

The dual mandate by the Federal Reserve reflects its two main goals: maintaining price stability and maximum sustainable employment. It defines price stability as keeping inflation at 2% each year while also trying to keep unemployment below 5%.

The dual mandate governs the policies of the Fed. If inflation is growing, the Fed will take steps to address it. If unemployment soars, the Fed will evaluate why and what can be done about it.

The dual mandate was established to guide the monetary policy of the FOMC so every member worked toward a common, clearly-defined goal.

Where Is the Federal Reserve?

The Federal Reserve is based in Washington D.C. and has 12 banks across the country. Its physical locations were developed long before banking was done digitally. The banks allowed people to travel within their district instead of needing to visit the nation’s capital for federal banking business.

The Federal Reserve has more than a century of history protecting the banks and supporting the American people. It continues to develop monetary policies that support growth while maintaining stability in the United States.