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The Fed Explained


The Fed Explains the Central Bank

When you're building something important, you need a good structure. What will make it last? How's it supposed to function? And what will make it strong? That's what the U.S. Congress was thinking about when they decided to build the Federal Reserve System. They needed to build something that would strengthen America's economy and its banking system so America could thrive.

In 1907, the nation went through a severe financial panic. So the U.S. president and Congress decided they needed a system that would help the economy run smoothly. A small group of nationally known politicians and financiers gathered at Jekyll Island off the coast of Georgia. Here, they constructed the outline that became the Aldrich Plan for development of the Federal Reserve System. This meeting was held in 1910, and the charter for the Federal Reserve was signed by President Woodrow Wilson in 1913.

The plan envisioned a central bank that has government oversight yet works independently. This means it's a central bank that can help keep the economy healthy without pressure from short-term political interests.

But the Fed alone doesn't have all the tools to keep the economy growing at a steady pace. The job is not one for a single organization and there's a difference between "monetary policy," the Fed's province that influences the economy by changing the supply and demand of money, and "fiscal policy," the province of Congress, which uses tax and spending changes to affect the economy.

So what does this mean to you? Well, the Fed is important because it keeps America's monetary system stable and growing with low inflation, and that allows people and businesses to make better buying and spending decisions, which fosters further growth, which helps keep the economy going in the right direction. But if the economy isn't healthy and money is tight, people may be afraid to spend and the economy won't grow. That's hard on everybody.

Today's Federal Reserve System is made up of the Board of Governors based in Washington, DC, and 12 regional Federal Reserve Banks spread across the country. Every six weeks or so, members of these two groups meet—the Board of Governors, including the chairman and the presidents of the regional Reserve Banks. At this meeting, they discuss and determine monetary policy direction. This meeting is called the Federal Open Market Committee, or FOMC.

The Federal Reserve has three important jobs. We call these functions the "three legs of the Federal Reserve stool." It sets monetary policy through decisions that affect the flow of money and credit in our economy, it contributes to the safety and soundness of our nation's financial system by supervising and regulating banks, and it serves as a bank for depository institutions and the federal government, helping the payment system work efficiently. In this capacity, the Federal Reserve System serves as the lender of last resort, a place where banks can turn when they can't obtain credit elsewhere and their inability to obtain credit could put the nation's economy at risk. In carrying out these three functions, the Fed also helps to contain risk that may arise in financial markets. Ultimately, it carries out its dual mandate given by Congress in 1977—that is, to keep prices stable and promote full or maximum employment.

Americans have always been reluctant to give too much financial power away. That's smart, but we still need somebody to foster conditions for a healthy economy. Since its founding in 1913, the Federal Reserve System has done just that, evolving to meet the needs of our changing financial system and growing economy. For more information about the structure and function of the Federal Reserve Bank, check out our website at www.frbatlanta.org.