|The Federal Reserve
This overview of the Federal Reserve
System is a digest of the publication The
Reserve System, Purposes and Functions, 8th edition,
1994, by the Federal Reserve Board of Governors.
throughout much of the 19th century. Many bank failures, business
bankruptcies, and economic downturns could be traced to a poorly
banking system and the lack of a flexible money supply. A
severe crisis in 1907 finally led Congress to establish the National
Commission to propose an institution that could deal with those
passed the Federal Reserve Act which Woodrow Wilson signed into law on
Dec 23, 1913. The act stated that its purposes were to "provide
the establishment of Federal reserve banks, to furnish an elastic
to afford means of rediscounting commercial paper, to establish a more
effective supervision of banking in the United States, and for other
Over the years,
deficiencies in the
original act have been addressed in further legislation. The
Banking Act of 1978, sometimes known as the Humphrey-Hawkins Act,
an update of the objectives of the Federal Reserve, namely to achieve
growth in line with the economy’s potential to expand; a high level of
employment; stable prices (meaning stability in the purchasing power of
the dollar); and moderate long-term interest rates.
The Federal Reserve
comprises the Board
of Governors in Washington D.C., and twelve regional Federal Reserve
Their responsibilities are to:
monetary policy by influencing the money and credit conditions in the
banking institutions to ensure safety and soundness of the nation’s
and financial system.
of the financial system.
services to the U.S. government, financial institutions, the public,
foreign official institutions, including a major role in operating the
nation’s payments system.
The Board of
as a federal agency. It is made up of seven members appointed by
the President and confirmed by the Senate. The full term of a
is fourteen years with appointments staggered so that one term expires
on January 31 of each even-numbered year.
The Chairman of the
for a four year term starting midway through each Presidential
Besides carefully monitoring domestic and international financial and
developments, the Board supervises and regulates the operations of the
Federal Reserve Banks. The Board is supported by a Washington
of about 1700.
The Board is audited
annually by a
major public accounting firm and is also subject to audit by the
Accounting Office, an arm of Congress. Monetary policy, which is exempt
from audit by the GAO, is monitored directly by Congress through
reports prepared by the Board.
The Federal Reserve
policy using three major tools: (1) open market operations to control
level of reserves in the depository system. (2) setting reserve
for depository institutions, and (3) setting the discount rate for
Policy regarding open
is the responsibility of the Federal Open Market Committee (FOMC)
the seven members of the Board, the president of the New York Federal
Bank, and the presidents of four other reserve banks on a rotating
However, the Board has sole authority over changes in reserve
and the discount rate.
Each Reserve Bank has
of nine directors chosen from outside the Bank. Three, designated
Class A, represent commercial banks that are members of the Federal
System. Three Class B and three Class C represent the public. The
member commercial banks in each district elect the Class A and B
The Board of Governors appoints the Class C directors, one of whom it
as chairman. No Class B or Class C director may be an officer,
or employee of a bank or a bank holding company. The directors in
turn nominate a president of the Reserve Bank, whose selection is
to approval of the Board of Governors.
The twelve Federal
banking services to depository institutions within their district, and
to the federal government. For depository institutions they
reserve and clearing accounts and provide various payment
These include collecting checks, electronically transferring funds, and
distributing and receiving currency and coin. For the federal
they act as fiscal agents. As such they maintain the Treasury
transaction account; pay Treasury checks; process electronic payments;
and issue, transfer, and redeem U.S. government securities.
The income of the
is derived primarily from the interest on U.S. government securities
it has acquired through open market operations. Other important
of income are the interest on foreign currency investments held by the
System, interest on loans to depository institutions, and fees for
provided to depository institutions such as check clearing, fund
and automated clearing house operations.
After it pays its
Reserve turns the rest of its earnings over to the U.S. Treasury.
About 95% of net earnings have been paid into the Treasury since
in 1914. The Board of Governors audits the Reserve Banks every
The Reserve Banks, like the Board, are subject to audit by the GAO, but
certain functions such as transactions with foreign central banks and
market operations are excluded from audit.
The nation's banks
three types according to which governmental body charters them and
or not they are members of the Federal Reserve System. Those
by the federal government (through the Office of the Comptroller of the
Currency in the Department of the Treasury) are national banks, and by
law are members of the System.
Banks chartered by
states are divided
into those that are members of the System and those that are not.
banks are not required to join the System, but they may elect to become
members if they meet the standards. As of June 30, 2006, there
a total of 7,480 commercial banks nationwide, of which 2,548 were
of the System. The Federal Deposit Insurance Corporation is
for supervising non-member banks.
Member banks must
in their regional Federal Reserve Bank in an amount equal to 3 percent
of their capital and surplus. They receive a 6 percent annual
on their stock and may vote for Class A and Class B directors of the
Bank. However the stock does not carry with it the control and
interest that is normal for the common stock of a for-profit
It offers no opportunity for capital gain and may not be sold or
as collateral for loans. The stock is merely a legal obligation
goes along with membership.
The Federal Reserve
to be an independent central bank. It is, but only in the sense
its decisions do not have to be ratified by the President or anyone
in the executive branch of government. However the entire system
is subject to the oversight of Congress because the Constitution gives
to Congress the power to coin money and set its value.
In 1913 Congress
to the Fed, and could reclaim it at any time. The Fed must act
the framework of the overall objectives of economic and financial
established by Congress. Thus the description of the System as
within the government" is more accurate.