The Federal Reserve System of the United States of America

The Federal Reserve System, also known as The Fed, is the central banking system of the United States of America. 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 monetary system in order to alleviate financial crises. 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. Nationally chartered commercial banks are required to hold stock in, and can elect some of the board members of, the Federal Reserve Bank of their region. The Federal Open Market Committee (FOMC) sets monetary policy. It consists of all seven members of the board of governors and the twelve regional Federal Reserve Bank presidents, though only five bank presidents vote at a time. The Federal Reserve System has both public and private components.

The primary declared motivation for creating the Federal Reserve System was to address banking panics. Other purposes are stated in the Federal Reserve Act, such as to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes. 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. Today, the Federal Reserve System has responsibilities in addition to stabilizing the financial system. Current functions of the Federal Reserve System include:

  1. To address the problem of banking panics
  2. To serve as the central bank for the United States
  3. To strike a balance between private interests of banks and the centralized responsibility of the government
  4. To supervise and regulate banking institutions
  5. To protect the credit rights of consumers
  6. To manage the nation's money supply through monetary policy to achieve the sometimes-conflicting goals of maximum employment, stable prices, including prevention of either inflation or deflation, and moderate long-term interest rates
  7. To maintain the stability of the financial system and contain systemic risk in financial markets
  8. To provide financial services to depository institutions, the U.S. government, and foreign official institutions
  9. To facilitate the exchange of payments among regions
  10. To respond to local liquidity needs
  11. To strengthen U.S. standing in the world economy

Addressing the problem of bank panics Banking institutions in the United States are required to hold reserves — amounts of currency and deposits in other banks — equal to only a fraction of the amount of the bank's deposit liabilities owed to customers. This practice is called fractional-reserve banking. As a result, banks usually invest the majority of the funds received from depositors. On rare occasions, too many of the bank's customers will withdraw their savings and the bank will need help from another institution to continue operating; 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 does occur. 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 Because some banks refused to clear checks from certain other banks during times of economic uncertainty, a check-clearing system was created in the Federal Reserve System. It is briefly described in the Federal Reserve System — Purposes and Functions as follows: Lender of last resort In the United States, the Federal Reserve serves as an institution's lender of last resort if it cannot obtain credit elsewhere and 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; whether public or private, the availability of liquidity was intended to prevent bank runs.

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