Federal Reserve System Definition – What is it?

Federal Reserve System – What is it?

When the Fed – that is, the Federal Reserve System – in America decides on the country’s future interest rate policy, this always has an enormous impact on the markets, which is not only limited to America, but can be felt worldwide beyond the country’s borders. But what exactly this Federal Reserve System is, how it came to be and what are the main tasks of the institution, that will be clarified here.

Federal Reserve System: definition & explanation

When reporting on the Federal Reserve System, in most cases it is referred to as the Federal Reserve or simply the Fed. By the Federal Reserve System is meant the Central banking system of the United States of America is meant. So, in a way, it is the equivalent of the European Central Bank, except that the Fed is limited to one country and not the entire euro area like the ECB.

The Federal Reserve System is divided into a total of three different institutions: First, the Fed includes the Board of Governors, which in some ways can be considered the leadership of U.S. central banks. The Board of Governors consists of seven individuals, each of whom is appointed by the U.S. President and confirmed by the Senate. The Board is responsible for ensuring that the concerns of American consumers are heard and taken into account in central bank decisions. Above all, however, it serves to control and coordinate the other two institutions.

One of these institutions is the twelve Federal Reserve Bankstheir main task is to implement in practice exactly what is determined by the Board of Governors. The 12 Federal Reserve Banks are distributed throughout the U.S. and each bank that reaches a certain size is required by law to become part of the Fed by acquiring shares in the Federal Reserve Banks.

The final institution is the Federal Open Market Committee. This consists of the seven members of the Board of Governors, on the one hand, and five presidents of the twelve Federal Reserve Banks, on the other. This committee ultimately makes the decisions that determine the monetary policy of the United States.

History of the Federal Reserve System

Since 1790, there have been repeated efforts for various reasons to stabilize the American economy by means of a Central bank to stabilize. After several failed attempts, an enormous economic crisis occurred at the end of the 19th century, which brought great uncertainty to all sectors of the economy. After enormous conflicts and disputes, as well as many other economically unstable phases, an agreement was reached in 1913 in the dispute over whether the Centralization of the banking system in the should be centralized. This led to the founding of the Fed on December 23, 1913. Over its now more than 100-year history, there have been several changes within the Fed. However, the core has endured to this day, so that the Fed can still be counted as one of the most influential financial institutions in the world.

Tasks of the Federal Reserve System

The Fed has several tasks, all of which can be summarized under the terms of Regulation and maintenance. For example, it is responsible for regulating how much money is in circulation in the United States. It does this by printing or destroying money on a daily basis. Likewise, the Fed is responsible for publishing the Beige Book eight times a year. This is the economic report of the USA. In this book, the twelve Federal Reserve Banks provide assessments of the current economic situation. Among other things, the Beige Book also serves as the basis for the meeting of the FOMCwhich always holds meetings two weeks after the publication of the Beige Book. On the basis of this, the FOMC decides, for example, on changes to the key interest rate.

All in all, it can be said that all activities of the Federal Reserve System are aimed at stabilizing the economy as well as prices and, for example, keeping unemployment rates as low as possible and achieving the highest possible economic growth.

Interest Rate Decisions and Meetings of the FED

As mentioned earlier, the Fed’s interest rate decisions are probably the decisions that have the most influence on the Stock Market and many other areas of the United States. The decision to change the federal funds rate is carried by the FOMC, which consists of all seven members of the Board of Governors plus five presidents of the Federal Reserve Banks. Interest rate decisions are made eight times a year, each two weeks after publication of the Beige Book. The decisions are based on a variety of data, mainly relating to the country’s economic and employment figures.

Depending on whether the key interest rate is raised or lowered, this is also felt on the stock market. As soon as the key interest rate is lowered, this means that private individuals often receive lower interest rates on their bank accounts as well. To get a higher return, they look for alternative investment opportunities. Generally speaking, this also makes it cheaper to obtain loans or similar. So overall, it is becoming easier to obtain money, so to speak. As a result, the price of gold, for example, can increase in value as a relatively crisis-proof investment, but the stock markets also usually receive a boost when the key interest rate is lowered by the Fed.

The situation is different as soon as the key interest rate is raised. Individuals can thus receive higher returns on their bank accounts. In particular, private individuals who are concerned about security are therefore withdrawing from the stock market and prefer to invest their money safely in an account.

In recent years, and especially since the Corona crisis, the Fed has shown itself to be particularly loose in its handling of the Interest rates and has lowered them further and further. This has led to comparatively stable economic and labor market data. However, this also increases the Risk of increased Inflationas more and more money enters the market. In the long term, therefore, it is difficult to maintain the current course, and once the corona crisis has been fully overcome, interest rates can be expected to rise again.

Differences between the Fed and the ECB

The Fed and the ECB differ primarily in their objectives. The ECB’s overriding goal is to keep prices as stable as possible for consumers. This means, for example, that inflation should be avoided as far as possible. To that end, the ECB has set a goal of achieving a maximum inflation rate of 2% each year. The Federal Reserve System, on the other hand, has several goals. In addition to stable prices, the main focus is on high employment rates, high economic growth and moderate interest rates in the long term.

Thus, while the ECB is concerned with preventing inflation, the Fed is willing to accept inflation if it can promote the achievement of its other goals.

Conclusion

So, as can be seen from the past, a central banking system in the U.S. is essential to avoid major economic crises. The Federal Reserve System has proven its worth and is capable of stabilizing and stimulating the U.S. economy.

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