The Federal Reserve, A simple Overview.

The Federal Reserve was established in 1913 in direct response to the Panic of 1907, a severe financial crisis that exposed critical weaknesses in America's banking system. In response, congress passed into law the US central bank - created to establish a monetary system that could respond effectively to stresses in the banking system. The Federal Reserve's structure is elegantly straightforward, consisting of two key components: The Board of Governors & 12 Federal Reserve Banks around the US.

Structure of the Federal Reserve.

The Board of Governors

The main people you've probably heard talked are the board of governors. They forms the central leadership of the Federal Reserve System, consisting of seven members appointed by the President and confirmed by the Senate for staggered 14-year terms.

The main goal: Promote financial stability through Monetary Policy.

Two main components of monetary policy

• Interest Rate Management
• Buying & Selling of government securities

How Interest Rate Management affects monetary policy.

Interest Rate management affects everyone in the US. The Federal Reserve determines the Federal Funds Rate - the interest rate that banks lend to each other over night. This may seem insignificant at first but in reality creates a strong ripple effect moving short term interest rates almost immediately. It becomes more expensive for banks to borrow money. Banks then pass these higher costs onto consumers through increased interest rates on loans. This increase will show up on auto loans, home loans, small business loans, trasury yields etc.

How Buying & Selling of government securities affects monetary policy.

This is commonly referred to Open market operations, just a fancy way of saying the Government buying or selling Government bonds on the open market. Buying bonds puts more money into circulation and Selling bonds takes money out of circulation. This directly affects how much money banks have to lend out.

Twelve Regional Federal Reserve Banks: The second component of the Federal Reserve.

These banks are supervised by the Central bank but also operate independently in many aspects.

What these banks do?

• Supervise and Examine banks within their geographic regions
• Enforce fair lending laws
• Lend to depository institutions (banks) to ensure liquidity

The US Central Bank supervises these 12 banks in appointment powers, budget approvals, and system-wide policy direction.

How it all connects

Monetary policy is adjusted at least 8 times a year by 12-person group of Federal Reserve System. This team is called the FOMC and consists of the 7 members of the Board of Governors, the president of the Federal Reserve Bank of New York; and 4 of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis.

At these meetings, the FOMC announces federal funds rate, financial regulation updates, reserve requirements etc.