What does the US Federal Reserve really do?

The Fed's Main Job: A Dual Mandate

The Federal Reserve operates under what is known as a dual mandate. Congress has given it two main goals that it must try to achieve at the same time. Think of it as trying to ride a bicycle while juggling. It's a delicate balancing act.

1. Maximum Employment

This goal means the Fed tries to create economic conditions where everyone who wants a job can find one. It doesn't mean zero unemployment, because people are always moving between jobs. Instead, it aims for the lowest possible level of unemployment without causing other problems, like runaway inflation.

2. Stable Prices

This is the Fed's fight against inflation. Inflation is when the prices of goods and services rise over time, which reduces the purchasing power of your money. The Fed generally aims for an average inflation rate of 2% per year. A little inflation is seen as healthy for the economy, but too much can be damaging. Keeping prices stable allows people and businesses to make financial plans with confidence.

How the Fed Controls the Economy

The Fed has several powerful tools to influence the economy and achieve its dual mandate. Its most famous tool is its ability to set a key interest rate. This ripples through the entire financial system.

The main tool is the federal funds rate. This is the interest rate that banks charge each other for overnight loans. While you don't pay this rate directly, the Fed's target for it affects all other borrowing costs.

• When the Fed raises interest rates: Borrowing money becomes more expensive. This means higher rates for your mortgage, car loan, and credit card debt. This discourages spending and borrowing, which helps to slow down the economy and control inflation.
• When the Fed lowers interest rates: Borrowing money becomes cheaper. This encourages people and businesses to spend and invest. This helps to speed up the economy and boost employment.

The group within the Fed that makes these important decisions is called the Federal Open Market Committee (FOMC). They meet about eight times a year to analyze the economy and decide whether to raise, lower, or hold interest rates steady. You can find their official meeting schedules and statements on their website. The FOMC's decisions are watched closely by investors and governments around the world.

Supervising Banks to Keep Your Money Safe

Another critical job of the Federal Reserve is to act as a supervisor for the country's banks. You want to know that the money you deposit in a bank is safe. The Fed helps ensure this trust.

It sets rules for banks and examines them to make sure they are financially healthy. Fed examiners check that banks are not taking on too much risk and have enough capital to cover potential losses. This helps prevent bank failures that could harm depositors and the wider economy.

The Fed also acts as the lender of last resort. If a healthy bank faces a short-term cash crunch and cannot borrow from other banks, the Fed can provide a temporary loan. This prevents a small problem from turning into a full-blown financial crisis. It provides a safety net that keeps the entire banking system stable.

The Fed's Major Impact on the Global Economy

The Federal Reserve's decisions are not just felt within the United States. Because the US dollar is the world's primary reserve currency, the Fed's actions have a huge effect on the entire global economy.

Most international trade and debt is priced in US dollars. This means companies and countries all over the world need and hold dollars. When the Fed changes its policies, it creates ripples everywhere.

For example, when the Fed raises interest rates, it usually makes the US dollar stronger compared to other currencies. This has several consequences:

• It becomes more expensive for other countries to buy American goods and services.
• It becomes harder for foreign governments and companies that have borrowed in US dollars to repay their debts. Their local currency is now worth less, so they need more of it to pay back the same dollar amount.

Conversely, when the Fed lowers rates, the dollar might weaken. This can help boost US exports and ease the debt burden on other nations. The Fed's actions can influence capital flows, trade balances, and financial stability across the world, making it a central player in the global economy.

Who Actually Runs the Federal Reserve?

There is a lot of confusion about the Fed's structure. Is it private or public? The answer is: it's a bit of both, and it is designed that way on purpose.

The Fed system has three main parts:

1. The Board of Governors: This is a government agency in Washington, D.C. It has seven members who are appointed by the US President and confirmed by the Senate for 14-year terms.
2. The 12 Regional Federal Reserve Banks: These are located in major cities across the country. They are structured like private corporations, and local commercial banks in their region are required to be shareholders. However, this ownership does not grant control.
3. The Federal Open Market Committee (FOMC): This is the group that sets monetary policy. It includes the seven governors, the president of the New York Fed, and four other regional bank presidents on a rotating basis.

This structure is meant to ensure the Fed remains politically independent. It can make tough decisions, like raising interest rates to fight inflation, without facing pressure from politicians who might be worried about an upcoming election. This independence is considered vital for the long-term health of the economy.