The Federal Reserve -- Outline
Structure and Functions

The Federal Reserve System is the Central Bank of the United States. The Fed was created in 1913, in response to a serious financial crisis that happened in 1907.

What is a central bank, and why do we need one? To find out, let's start by explaining what the Federal Reserve, or "The Fed" does. It:
1. Manages money and operates at the center of the nations' financial system, conducting monetary policy and serving as a "lender of last resort"
2. Supervises and regulates a large share of the nation's banking and financial system

How the Fed is Organized
The Federal Reserve System was created as an independent agency of the US government to provide a safer and more flexible banking and monetary system. To ensure autonomy, it was stipulated that the Fed's operations would be financed from its own resources to insulate it from political pressures.

1. Board of Governors: At the apex of the Federal Reserve System is a seven-member Board of Governors based in Washington, DC. Appointed by the President of the United States and confirmed by the Senate, Governors serve 14-year terms. The President of the US also designates a Chair and a Vice-Chair from the Board to serve 4-year terms. These are approved by the Senate and can be renewed. Twice a year, the Chairman of the Fed's Board of Governors reports to Congress on the FOMC's (see below) economic views. The goals of the Fed are to achieve economic growth with stable prices (low inflation.)

2. District Banks: There are 12 Federal Reserve Districts throughout the United States. Regional headquarters are located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco.

3. Federal Open Market Committee (FOMC): The FOMC has 12 voting members - the seven members from the Board of Governors and five Reserve Bank presidents. The President of the Federal Reserve Bank of New York serves as a permanent Vice-Chair of the FOMC and is always a voting member. The other presidents serve 1-year term on a rotating basis. While all 12 Reserve Bank presidents participate in every FOMC meetings, only those serving as members may vote. The FOMC meets 8 times per year in Washington, DC. For each session, economists at the Board of Governors and the Reserve Banks prepare extensive economic analysis of statistics from every industry and region in the country. These are compiled in what is called the Beige Book. These reports are used in the formulation of monetary policy.

The Fed's Role in Monetary Policy
The country's economic performance is influenced by many factors --consumer spending, business investment decisions, fiscal policy determined by the legislative and executive branches of government, and monetary policy carried out by the Federal reserve. The Fed uses three tools to influence the availability of money and credit -- the reserve requirement, the discount rate, and open market operations. Here is how each one works:

1. Reserve Requirements: By law, financial institutions set aside a percentage of their deposits as reserves which can be held either as cash on hand, or as account balances at Reserve Banks. For example, increasing the reserve requirement ratio decreases the amount of money financial institutions have to lend. Decreasing the required reserve ratio frees funds that were previously set aside, thus releasing money into the economy. Because a change in reserve requirement can have dramatic long-term effects on the economy, the Fed prefers using other monetary policy tools.

2. The Discount Rate: The basic discount rate is the interest rate a Reserve Bank charges eligible institutions to borrow funds for a short term. Under some circumstances, changes in the discount rate can affect the supply of credit in the economy. Changing the discount rate can also have an "announcement" effect, which influences market psychology.

3. Open Market Operations: The Fed's most flexible and often used tool of monetary policy is open market operations, that is, the buying and selling of government securities in the open market. The FOMC sets the Fed's policy, which is carried out through the trading desk of the Federal Reserve Bank of New York. If the FOMC decides that money and credit should be more available, it directs the trading desk to buy securities from the open market. The Fed pays for these securities by crediting the reserve accounts of banks involved with the sale. With more money in their reserve accounts, banks have more money to lend, and interest rates may decline. To "tighten" the money supply, the Fed sells government securities and collects payments from banks by reducing their reserve accounts. With less money in their reserve accounts, banks have less money to lend and interest rates may increase. Read about how to conduct monetary policy here.

In summary, Monetary Policies are decisions by the Federal reserve System that lead to changes in the supply of money and the availability of credit. Changes in the money supply can influence overall levels of spending, employment, and prices in the economy by inducing changes in the interest rate charged for credit, and by affecting the levels of personal and business spending. The major monetary policy tool that the Fed uses is open market purchases and sales of government securities.