Overview

The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of financial panics led to the desire for central control of the American monetary system. Although an instrument of the U.S. government, the Federal Reserve System is considered an independent central bank due to its structural insulation from political interference.

Over the years, events such as the Great Depression in the 1930s and the Great Recession during the 2000s have led to the expansion of central bank's remit.

Congress established three key objectives for monetary policy in the Federal Reserve Act: maximizing employment, stabilizing prices, and moderating long-term interest rates. The first two objectives are sometimes referred to as the Federal Reserve's dual mandate. Its duties have expanded over the years, and include supervising and regulating banks, maintaining the stability of the financial system, and providing financial services to depository institutions, the U.S. government, and foreign official institutions.

The Fed also conducts research into the economy and provides numerous publications, such as the Beige Book and the FRED database.

The Federal Reserve System is composed of several layers. It is governed by the presidentially appointed board of governors or Federal Reserve Board (FRB). Twelve regional Federal Reserve Banks, located in cities throughout the nation, regulate and oversee privately owned commercial banks. The Federal Open Market Committee (FOMC) sets monetary policy by adjusting the target for the federal funds rate, which generally influences market interest rates and, in turn, the American economy via the monetary transmission mechanism.

Purpose

Before the founding of the Federal Reserve System, the United States underwent several financial crises. A particularly severe crisis in 1907 led Congress to enact the Federal Reserve Act in 1913. The primary declared motivation for creating the Federal Reserve System was to address banking panics. Other stated purposes, are "to furnish an elastic currency, to afford means of rediscounting commercial paper, [and] to establish a more effective supervision of banking in the United States".

Fractional-reserve bank

Banks usually invest the majority of the funds received from depositors. However, banking institutions in the United States are required to hold reserves‍—‌amounts of currency and deposits in other banks‍—‌equal to a fraction of the amount of the bank's deposit liabilities owed to customers. This practice is called fractional-reserve banking. On rare occasions, too many of the bank's customers will withdraw their savings such that the bank cannot continue operating on its own; this is called a bank run. Bank runs can lead to a multitude of social and economic problems.

The Federal Reserve System was designed as an attempt to prevent or minimize the occurrence of bank runs, and possibly act as a lender of last resort when a bank run occurs. Many economists, following Nobel laureate Milton Friedman, believe that the Federal Reserve inappropriately refused to lend money to small banks during the bank runs of 1929; Friedman argued that this contributed to the Great Depression.

Check clearing system

Before the establishment of the Federal Reserve, during times of economic uncertainty, some banks refused to clear checks from certain other banks, which led to large-scale bank failure in the early 20th-century. Hence, a national check-clearing system was created in the Federal Reserve System. The Federal Reserve can physically accept and transport cheques.

Lender of last resort

In the United States of America, the Federal Reserve serves as the lender of last resort to those institutions that cannot obtain credit elsewhere, institutions the collapse of which would have serious implications for the economy. It took over this role from the private sector clearing houses which operated during the Free Banking Era. The availability of liquidity is intended to prevent bank runs.