We all hear about The Fed, or Fed Chairman, but what is this banking body and what does it do? The Fed is the nickname of the Federal Reserve, the central bank for the United States. It was the 1913 Federal Reserve Act that paved the way for a central banking system to respond to the financial needs of a still-growing country.
The Fed sets the nation’s monetary policy, which impacts the amount of money and credit in the U.S. economy. Impacts on money and credit affect interest rates, which indicate the cost of credit; rising interest rates can adversely affect people’s spending ability. The Fed has three tools at its disposal to set monetary policy – open market operations, the discount rate and reserve requirements.
Open market operations means there is competition among buyers to purchase U.S. government securities; the Fed does not decide with whom it will do business to sell these assets. The purpose of this buying and selling of assets is to affect the federal funds rate, which is the rate that banks charge to borrow from each other. For example, the idea behind buying funds from securities dealers is to inject the market with capital, effectively creating money. Selling securities has the opposite effect.
The discount rate is the interest rate the Fed charges to other banking institutions on short-term loans, while reserve requirements are portions of deposits banks must maintain either on site or in one of 12 Federal Reserve Banks in the country.
The Federal Open Market Committee is the Fed’s chief policymaking body, charged with managing the nation’s money supply. The FOMC meets eight times a year in Washington, D.C. to discuss monetary policy options. The chairman of the Fed’s Board of Governors, currently Ben Bernanke, also leads the FOMC.
To illustrate the impacts of the Fed on current monetary policy, consider this brief excerpt from an April 2009 press release: “… Economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” In other words, the Fed plans to keep the borrowing rate between banks low to ideally bring liquidity back to the market.
For more information on the Federal Reserve, visit www.federalreserve.gov.