What the Federal Reserve does?

The Fed, the US central bank, has consistently made headlines as its decisions can affect global economic trends. As investors, we need to know the basics about the Fed to make more informed investment decisions.

The Creation of the Fed

The story began in the 19th century when the US saw its banking and monetary systems expand exponentially thanks to the booming industrial economy after the Civil War.

However, the inflexible currency circulation and supply couldn't meet people's needs. These destabilizing factors resulted in panic and bank runs.

The severe panic in 1907 triggered the first global financial crisis of the 20th century. But it also brought about a wave of monetary reforms.

In 1913, to stabilize the domestic banking system, and meet the public's demand for liquidity, the US Congress created the Federal Reserve System, also known as "the Fed".

Five key functions of the Fed

Today, to promote the effective operation of the US economy, the Fed performs broader responsibilities.

Its five key functions are

1. conducting monetary policy;

2. promoting the financial system's stability;

3. supervising and regulating financial institutions;

4. fostering payment and settlement system safety and efficiency;

5. promoting consumer protection and community development.

Among these five functions, conducting monetary policy generally receives the most attention. Its monetary policy goals are twofold: achieve maximum employment and stable prices. Besides the Fed's key role in Americans' lives, the US dollar's dominance in international trade and financial markets also explains why the Fed's actions, like the interest rate hikes or cuts, are so closely watched by global investors.

How does it work exactly?

You may wonder: as the Fed performs so many critical functions, how does it work exactly? Actually, the Fed system includes three key components: the Board of Governors, twelve Federal Reserve Banks, and the Federal Open Market Committee (i.e., FOMC).

The Board of Governors sits at the heart of the system. It has 7 members, including the chair and vice chair. Their duties include studying economic issues, setting the nation's monetary policy, and overseeing Reserve Banks' activities.

Located in cities throughout the country, twelve regional Federal Reserve Banks, act as a "bridge" between the center and the regions. While helping to implement monetary policy, they also bring local economic insights to the national arena.

FOMC, the Fed's chief body for monetary policy, consists of 12 voting members —the 7 members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining 11 Reserve Bank presidents who serve on a one-year rotating basis. The FOMC typically meets eight times a year to discuss monetary policy options.

This is the Fed, one of the most influential financial institutions in the world.