The Fed Makes and Conducts Monetary Policy

Monetary policy influences the economy through its effect on the quantity of reserves that banks use to make loans. Policy actions that add reserves to the banking system encourage lending at lower interest rates thus stimulating growth in money, credit, and the economy. Policy actions that absorb reserves work in the opposite direction. The Fed's task is to supply enough reserves to support an adequate amount of money and credit, avoiding the excesses that result in inflation and the shortages that stifle economic growth.

The Fed seeks to control bank reserves primarily with its open market operations — the purchase and sale of government securities. The Fed can also influence money and credit conditions by changing its discount rate and reserve requirements. The discount rate is the interest rate that banks pay to borrow reserves from Federal Reserve Banks. Reserve requirements are the percentages of deposits banks must hold in vault cash or at a Reserve Bank.

Monetary policy decisions are made by the Federal Reserve governors and the presidents and directors of the Reserve Banks. The Federal Open Market Committee, comprised of Fed governors and presidents (see organization diagram), oversees open market operations conducted every business day. The Reserve Bank directors establish the discount rate every two weeks, subject to the approval of the Board of Governors. The Board sets reserve requirements, but changes them only rarely.

Money growth and inflation are very closely associated over time. For that reason, monetary policymakers widely agree that the Federal Reserve should strive to eliminate inflation by holding money growth in check. This emphasis on the goal of price stability reflects a conviction that its achievement will help the national economy reach other objectives — high employment, strong growth, and balance in international accounts.

The Fed Buys and Sells Foreign Currencies

The Federal Reserve cooperates with the Treasury in carrying out foreign exchange operations. These actions are usually conducted by the Fed to offset disruptive international capital flows rather than to influence domestic money and credit conditions.

The Fed Reports to Congress

The Federal Reserve is directly responsible to the Congress of the United States. The Federal Reserve Chairman makes periodic reports of Fed actions and policies to Congress. A particularly important Fed report is the Chairman's semiannual review of recent monetary policy along with the Fed's assessment of the economic outlook.

Congressional committees often ask the Chairman and other Fed officials to testify on legislation related to issues in banking and finance.

THE FED CONFERS WITH OTHERS

Fed officials and staff maintain contact with the business, financial, and academic communities, with foreign central banks and international financial organizations, and with federal, state, and local government officials and staff.

THE FED STUDIES BANKING AND THE ECONOMY

The Federal Reserve collects and processes a great deal of financial data and some nonfinancial data such as that used to compile the Fed's index of industrial production. The Reserve Banks also gather anecdotal economic information for the Fed's regular report on regional economic activity.

Most Federal Reserve research relates to three areas: macroeconomics and monetary policy (including international finance), financial institutions and the payments system (including international aspects), and regional economic analysis. Research results are used internally and published in periodicals and special publications.

The Fed Informs the Public

The Federal Reserve provides a broad range of informational and educational services to the public. The Fed's public information activities include reporting data and economic indicators, participation in economic education programs, and publishing materials related to the purposes and functions of the Federal Reserve.

The Fed Protects the Financial System

Congress has assigned the Federal Reserve important responsibilities for banking regulation and supervision. As a regulator, the Fed writes and issues rules of conduct to implement banking laws. As a supervisor, the Fed directly examines and otherwise oversees certain banking institutions.

The Federal Reserve regulates and supervises its state-chartered member banks and all bank holding companies, Edge Act and agreement corporations, financial holding companies, and U.S. activities of foreign banks. The Fed also regulates the bank merger, acquisition, and foreign activities of its members and of commercial banking organizations operating abroad through Edge corporations. (National banks are all members of the Federal Reserve System. State-chartered banks that qualify may elect to become Fed members. Bank holding companies are companies that own one or more banks. Edge corporations are U.S. chartered banking organizations limited to international banking activities. Financial holding companies are special bank holding companies that are permitted to make certain investments in nonfinancial companies.)

The Fed Lends When Others Won't

The Federal Reserve is the lender of last resort, responsible for forestalling national liquidity crises and financial panics. By lending against satisfactory collateral through their "discount windows," Reserve Banks can help protect the safety and soundness of the nation's financial system.

The Fed Regulates Credit Purchases of Securities

The Federal Reserve sets margin requirements — the percentage cash down payment required for purchasing stocks and related securities.

The Fed Protects Consumers and Communities

The Federal Reserve establishes rules to protect consumers in their credit transactions and to encourage banks to help meet the credit needs of their communities. Laws that pertain to these Fed responsibilities include the Truth in Lending, Equal Credit Opportunity, Truth in Savings, Consumer Leasing, Privacy, and Community Reinvestment Acts.

The Fed Sells Services to Banks

The Federal Reserve works to improve the efficiency of the payments system — the ways funds move — by supplying priced services to banks. These services offered by the Reserve Banks include:

• Check processing. Banks can send other-bank checks deposited with them to Reserve Banks for collection and settlement. The Reserve Banks also provide electronic services that speed up the collection of checks.
• Electronic transfers. Banks can use the national Fedwire network to almost instantaneously move their funds and those of their customers.
• Securities. Banks can hold government and corporate securities at Reserve Banks for safekeeping and collection of coupons and matured issues. Banks can also use the Fed to wire-transfer U.S. government securities and to buy and sell Treasury securities.
• Automatic deposit and payment. Banks can use the Federal Reserve to offer their customers direct payroll deposit and automatic payment of recurring bills (e.g., mortgages and utilities). Also, with Fed services, banks can offer cash concentration to businesses receiving payments at several locations.
• Accounting. The Reserve Banks hold reserves that banks use to satisfy legal requirements and to settle among themselves. The Fed offers banks several services with these accounts, including account management and information services. Banks can also participate in a Fed cost accounting service.

The Fed Provides Services to the U.S. Government

The U.S. government has its checking accounts at the Federal Reserve. All U.S. Treasury checks are written on these Reserve Bank accounts.

As fiscal agent for the U.S. government, the Fed issues, redeems, and services Treasury bills, notes, and bonds, including savings bonds. The Federal Reserve provides these services to banks and individuals without charge.

The Fed supports a key payments function by supplying coin and currency to banks as needed to meet public demand, and by retiring unfit currrency. The Fed receives new coin and currency from the U.S. Mint and Bureau of Engraving and Printing, and ships these new monies to banks when necessary. The Reserve Banks also process food coupons.

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(The word bank is used for depository institutions in this brochure.)