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The Federal Reserve Bank

The vast operations of our contemporary central bank in managing the money supply are crucial to stabilizing the economy and making the United States a country in which its citizens can live, do business, and prosper.

People line up to withdraw money from ATMs.

Founded with a singular purpose in 1913, the Federal Reserve Bank of today has become an integral component of the economy's inner workings.

The Federal Reserve Bank (FRB) is a common topic in the news, when reporting changing interest rates, the latest consumer protections, and financial scandals. Many U.S. citizens, however, are unaware of the Federal Reserve Bank's function, purpose, and operations. Understanding how the Federal Reserve works will help you understand its role in your everyday life. 

Original Purpose

The Federal Reserve Bank first came into being when President Woodrow Wilson signed the Federal Reserve Act in 1913. At the time, economic ups and downs were common. The downturns could be quite painful, constricting the supply of money, causing deflation, and leaving people unemployed. The initial purpose of the Federal Reserve Bank was to act as a "lender of last resort," lending money to banks to encourage them to extend more commercial loans. As a last resort lender, the Federal Reserve Bank was always intended to have a stabilizing influence on the United States's economy.

Contemporary Federal Reserve Function

Today, the Federal Reserve has twelve regionally located branches. Overseen by the Federal Reserve Board of Governors and the Federal Open Market Committee located in Washington D.C., the FRB functions as the central banking system for the United States. The FRB houses a complex system of monetary policy and additional facilitatory responsibilities. The modern Federal Reserve Bank's responsibilities fall into five categories. 

  • Conducting Monetary Policy
  • Stabilizing the Financial System
  • Regulating and Supervising Financial Institutions
  • Facilitating the Safety and Efficiency of the Payment and Settlement System
  • Protecting Consumers

The responsibilities of the FRB are numerous, but many would argue that the central bank's most important function is managing the money supply within the U.S. economy.

How the Federal Reserve Bank Manages the Money Supply

The Federal Reserve Bank manages the money supply to foster the healthy growth of the economy by limiting the supply when the economy expands too quickly and increasing it in the face of a potential downturn. Through its monetary policies, the Federal Reserve has three powerful tools it uses to control the money supply and stabilize the economy:

  1. Changing the Required Reserve Ratio - Banks are required to maintain a cash reserve equal to a certain percentage of their deposits. To limit supply, the Federal Reserve increases the ratio. To increase the money supply, it lowers the reserve ratio.
  2. Changing the Discount Rate - Sometimes banks must borrow money for cash reserves from the FRB. When the Federal Reserve lends cash reserves to banks, it charges interest on the loan. Adjusting this interest rate up or down respectively discourages or encourages spending and reduces or increases the supply of money.
  3. Open Market Operations - The Federal Reserve manages securities, selling them to and buying them back from banks and large securities dealers. When the Federal Reserve sells securities, the money supply decreases, and when they purchase securities, liquid cash is pumped back into the system. When a bank receives a check for a sold security from the FRB, that bank's reserve ratio increases, which encourages the bank to make more loans, increasing the money supply available in the market.

Although the Federal Reserve Bank's original role, encouraging lending to commercial customers, is still important today, the vast operations of our contemporary central bank in managing the money supply are crucial to stabilizing the economy and making the United States a country in which its citizens can live, do business, and prosper.