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Most of us have heard of the Federal Reserve and know that the “Fed” has a role in setting interest rates, but many are unaware of what the Fed is and what it actually does.
The Federal Reserve has been in the news a lot lately, as they have indicated that they will allow a higher level of inflation. One of the Fed’s main functions is to provide price stability throughout the economy. Their willingness to accept a higher rate of inflation means that they are likely to continue to keep interest rates low.
The Federal Reserve, or the Fed, is the central bank of the United States. It was created by Congress in response to a series of financial panics. The Fed’s mandate is to provide the nation with a safer, more flexible and stable financial system. The Fed is headquartered in Washington, D.C. and consists of a network of 12 regional Federal Reserve banks. The Fed is managed by a board of governors.
The board of governors has seven members, appointed by the president and confirmed by the Senate. They serve 14-year terms and the terms are staggered so one governor’s term expires each even-numbered year. A chairman and vice chairman lead the board, each serving a four-year term in that capacity.
The chair and vice chair positions on the board of governors also requires presidential appointment and Senate confirmation. The current chair of the Fed is Kevin Warsh. He was sworn in on May 22 after being appointed by President Trump in January.
The Federal Reserve System is divided into 12 districts. The districts are headquartered in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco. We are located in the Chicago district.
The Fed is tasked with conducting the nation’s monetary policies, specifically pursuing full employment and maintaining stable prices, and moderate long-term interest rates. They also supervise and regulate banking institutions and maintain the stability of the financial system. The Fed also provides services to depository institutions by playing a role in the nation’s payment system and by distributing coins and bills.
The Fed determines monetary policy through the Federal Open Market Com-mittee, or the FOMC. The FOMC has 12 members: the seven members of the board of governors, the president of the Federal Reserve Bank of New York and four at-large members. The FOMC holds eight scheduled meetings per year. It is actually the FOMC that decides whether or not to change the federal funds rate. This is the rate we mean when we say the Fed raised or lowered rates.
Banks deposit money with the Fed and are required to maintain certain levels of reserves. Some banks have excess reserves and others have too few. Banks with excess reserves make overnight loans to banks with inadequate reserves.
The federal funds rate is the rate banks charge each other for these overnight loans. The FOMC targets a specific level by making more or less reserve balances available to the banking system. The federal funds rates in turn, directly influences other rates such as deposit rates, prime rate, credit card rates and mortgage rates. When the economy is growing too slowly, the FOMC lowers the target rate to stimulate economic growth. When there is a danger of inflation from the economy growing too quickly, the FOMC will raise the target rate to slow demand and restrain inflation.
Inflation is a result of too much money chasing too few goods and services. A stable price level is one of the Fed’s main goals. When the economy experiences inflation, the purchasing power of the currency goes down, and if prices rise faster than personal income, the economy will experience a decrease in the standard of living. Prices naturally rise over time as the economy grows, but the important thing is the incomes keep up with the increases in prices.
Hopefully, this will take a little bit of mystery about what the Fed is and the role it plays in our economy. The Federal Reserve System is not perfect, but it has been successful in achieving its mission over time.
Important Disclosure:
Michael Bergen is a Partner, Managing Director at Beacon Pointe Advisors LLC. The information contained in this article is for general informational purposes only. Opinions referenced are as of the publication date and may be modified due to changes in the market or economic conditions and may not necessarily come to pass. Past performance is not a guarantee of future results. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified or attested to the accuracy or authenticity of the information.
The discussions, outlook and viewpoints featured are not intended to be investment advice and do not consider specific investment objectives or risk tolerance you may have. All investments involve risks, including the loss of principal. Consult your financial professional for guidance specific to your circumstances.
