The Federal Reserve, also known as the Fed, is the central banking system in the United States. It is the premier financial and economic institution in the country. The Fed has multiple functions under its charter of responsibilities, some of which include deciding on interest and mortgage rates, checking the money flow, and regulating banks. Its decision not only helps shape the US economy, but also gives direction to the global financial flow.
US Federal Reserve: Its Existence
The US Federal Reserve was established in December 1913. It was set up under the Federal Reserve Act with an aim to present a solution to financial downs, especially in 1907, in the US market. To stabilise the fluctuating economy, this system was introduced. It has undergone several changes, including a few drastic ones, in the last century and more to exist in its present form.
The Fed has also been the driving force of bringing the US economy back to being powerful after the Great Depression and the Great Recession.
The objectives and responsibilities of the US Fed
When the Fed was established under the Federal Reserved Act by the Congress, it had three key monetary policies. These included maximising employment, stabilising prices, and moderating low-term interest rates. Among these three, the first two responsibilities are also popularly known as the Federal Reserve’s dual mandate.
Since its establishment, the scope of responsibilities for the US Federal Reserve has expanded. It also supervises banks in the US along with regulating them and stabilising the overall financial structure. The Federal Reserve acts as a key finance distributor for depository institutes, the US government as well as the foreign establishments.
Structure and functions of the Federal Reserve
The Federal Reserve oversees 12 regional Reserve Banks across the US. They can be rightly called the operating arms of the Fed and function within their geographical Districts. Each of these banks have nine Board of Directors that acts as a liaison between the Fed and the private sector.
The Board of Governors for the Fed sits in Washington DC. It includes seven members, who are nominated by the US President and approved by the Senate prior to their appointment.
Each member is appointed to serve a 14-year term, subject to Senate’s approval. The other two members are the US President and the Fed Chair. This Board is answerable to the Congress about the functions and progress of the Federal Reserve. The Chair controls the Federal Open Market Committee (FOMC). It takes major monetary decisions including the setting of federal funds rate.
How has the Fed’s role evolved over the years?
In 1999, the US banking system underwent a major reform under a law that legalised the merger of securities, insurance, and banking systems as well as allowed the combining of retail and investment. These functions were earlier separated under the 1933 Glass-Steagall Act. Later, the financial crises in the US, including the Recession of 2008, raised questions of the oversight of the Fed. Two of the major reasons for this disaster were the repeal of the Glass-Steagall Act and the 2000s rule that allowed the banks to take unprecedented debt from the Fed.
To deal with the Recession, the Fed slashed the interest rates to nearly zero with an aim to boost lending and other economic activities. The rates stayed lower until 2015. However, the Fed did not follow the example of several other banks, such as in Japan. It decided to keep the rates at nearly zero and were against going into negative. Such initiatives helped the US economy to boost after suffering one of the greatest bumps.
Impact of US Federal Reserve on the Global Economy
The US economy is one of the strongest. Any decision taken by the Fed also has a global impact. Two of the primary reasons for this impact include the designation of the US dollar as the primary reserve currency and functioning of US treasury bonds as the safest investment.
The investors put their money in and out of the market based on the interest rates decided by the Fed. If the rate increases, the money is immediately withdrawn, which is then invested in the US assets in hope for secure and high yields. Contrary to this, the decrease in interest rates results in the opposite flow of money.
Increase in US interest rates strengthens the dollar, weakening other economies. This also makes imports expensive in other countries, leading to inflation. When the interest rates in the US are lower or stable, it helps to stabilise regional economies and manage cost of import, while controlling inflation. Other sectors impacted by the decision of the Fed include foreign investment, currency valuation, sector-specific trends, as well as inflation management.