Federal Reserve System (FRS): Functions and History

What Is the Federal Reserve System (FRS)?

The term Federal Reserve System (FRS) refers to the central bank of the U.S. The Fed, as it is commonly known, regulates the U.S. monetary and financial system. The Federal Reserve System is composed of a central governmental agency in Washington, D.C., the Board of Governors, and 12 regional Federal Reserve Banks in major cities throughout the U.S. The Fed's central role is to handle the country's monetary policy, among other things.

Understanding the Federal Reserve System (FRS)

The Federal Reserve System is the central banking system of the United States. It is a major force in the country's economy and banking industry. The bank is headed by the governor and has a board with six other members. These individuals are nominated by the president and are then confirmed by the Senate.

The Fed performs five general functions:

• Conducting the nation's monetary policy
• Regulating banking institutions
• Monitoring and protecting the credit rights of consumers
• Maintaining the stability of the financial system
• Providing financial services to the U.S. government
  

The Fed also operates three wholesale payment systems, including the Fedwire Funds Service, the Fedwire Securities Service, and the National Settlement Service.

The Fed has broad power to act to ensure financial stability, and it is the primary regulator of banks that are members of the Federal Reserve System. It acts as the lender of last resort to member institutions who have no place else to borrow.

The Fed's open-mouth operations are known to publicly declare the current interest rate. Banks in the U.S. are also subject to regulations established by the states, the Federal Deposit Insurance Corporation (if they are members), and the Office of the Comptroller of the Currency (OCC).

Fed Payments

The Fed uses two payment systems: Fedwire and FedNow. The FedNow service allows for instant payments. As the Fed describes, "payments that can be sent and received within seconds at any time of the day, on any day of the year, such that the receiver can use the funds almost instantly."

Fedwire is a payment service for financial institutions that hold an account with the Fed. According to the Fed, it is a "real-time gross settlement system that enables participants to initiate funds transfer that are immediate, final, and irrevocable once processed." It is used to make large-value, time-critical payments.

History of the Federal Reserve System

The Fed was established by the Federal Reserve Act, which was signed by President Woodrow Wilson on Dec. 23, 1913, in response to the financial panic of 1907. Before that, the U.S. was the only major financial power without a central bank.

The following are some key highlights in the Fed's history:

• When the Federal Reserve Act was established, it required commercial banks to hold reserves at their local Reserve Bank. Banks were able to borrow additional funds if and when needed by approaching the discount window. The discount window is the lending facility that helps commercial banks meet their short-term liquidity needs.
• The Fed went through several changes in its early years. For instance, there were changes made to the way it works after the Great Depression. The Fed's board received more power (which was shifted from the 12 Reserve Banks) with the passing of the Banking Acts of 1933 and 1935.
• The Federal Reserve Reform Act, which was established in 1977, required the central bank to report to Congress with its goal of achieving maximum employment and reaching its inflationary targets.
  

Federal Reserve System (FRS) vs. Federal Open Market Committee (FOMC)

The Federal Open Market Committee (FOMC) is the Fed's monetary policy-making body and manages the country's money supply. It is made up of the seven members of the Fed's board of governors, the president of the New York Fed, and four of the remaining 11 regional Fed presidents, who serve one-year terms on a rotating basis. The FOMC meets eight times a year and additionally on an as-needed basis to discuss the outlook for the national economy and review options for its monetary policy.

The FOMC adjusts the target for the overnight federal funds rate, which controls short-term interest rates, at its meetings based on its view of the strength of the economy. When it wants to stimulate the economy, it reduces the target rate. Conversely, it raises the federal funds rate to slow the economy.

Here's a history of how the target rate has moved in recent years:

• The target rate was lowered to 0.25% in response to the recession in 2008 and stayed there for seven years.
• On Dec. 16, 2015, the Fed raised the target rate to a range of 0.25% to 0.5%—the first rate hike in almost 10 years.
• The FOMC increased the rate up to a range of 2.0% to 2.25% starting Aug. 1, 2019.
• The rate fell drastically to the 0% to 0.25% range when the Fed announced the change on March 16, 2020. The Fed cited issues stemming from the COVID-19 pandemic.
• Since then, primarily to combat high inflation, the rate has increased dramatically. The FOMC began increasing rates in 2022 and continued to do so through 2023, all the way to the range of 5.25% to 5.5%, which was the last increase, set at the FOMC meeting in July 2023.
• Subsequent FOMC meetings have kept rates at the same level, which the FOMC confirmed in its July 2024 meeting.
• The FOMC announced that it dropped the target range by half a percentage point to 4.75% to 5%, citing tapering inflation and a balance of risks.

The Bottom Line

The Federal Reserve System refers to the central bank of the United States. The Fed, as it is commonly known, sets the monetary policy of the United States. Its responsibilities also include regulating banking institutions, monitoring and protecting the credit rights of consumers, maintaining the stability of the financial system, and providing financial services to the U.S. government.