The Federal Reserve System

Business Credit, July-August 1995 | Go to article overview

The Federal Reserve System


Editor's Note: We've had several questions about the Federal Reserve System - how it works - how do the regional banks operate. Here is the first article in a series designed to address these questions.

To many people, the operations of the U.S. Federal Reserve System are more than confusing, they can be downright mysterious. Sure, our politicians and newscasters can often be heard referring to "the Fed," but how many of us really understand this complex part of the American government and economy?

The Federal Reserve System was founded by Congress in 1913 and today remains the central bank of the United States. The Fed provides the nation with a safer, more flexible, and more stable monetary and financial system; over the past 80 years, its role in banking and the economy has changed and expanded.

Today, the Federal Reserve's duties fall into four general areas:

* Conducting the nation's monetary policy by influencing the money and credit conditions in the economy in pursuit of full employment and stable prices;

* Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers;

* Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets;

* Providing certain financial services to the U.S. government, to the public, to financial institutions, and to foreign official institutions, including playing a major role in operating the nation's payments system.

The Fed is not unique in the global marketplace; most developed countries have a central bank whose functions are similar to those of the Federal Reserve. The Bank of England has served as a central bank since the end of the 17th century. Napoleon I established the Banque de France in 1800, and the Bank of Canada was founded in 1935. The German central bank was dismantled, then reestablished after WW II and is loosely modeled on the Federal Reserve.

Background

One of the driving forces creating the need for a central bank in any country is the problem of financial crises and resulting panic. Before Congress created the Federal Reserve System, financial panics had plagued the nation. Such panics contribute to bank failures, business bankruptcies, and general economic downturns. A particularly severe crisis hit in 1907 and prompted Congress to establish the National Monetary Commission, which proposed to create a national institution that would deter such crises. After considerable debate, Congress passed the Federal Reserve Act, which President Woodrow Wilson signed into law on December 23, 1913. According to the act, the Fed's purposes are, "to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes."

Shortly after the Fed was created, Congress realized that the act had broader implications for national economic and financial policy. Subsequent legislation has clarified and amended the Fed's original outlined purposes. Key laws affecting the Federal Reserve include the Banking Act of 1935; the Employment Act of 1946; the 1970 amendments to the Bank Holding Company Act; the International Banking Act of 1978; the Full Employment and Balanced Growth Act of 1978; the Depository Institutions Deregulation and Monetary Control Act of 1980; the Financial Institutions Reform, Recovery, and Enforcement Act of 1989; and the Federal Deposit Insurance Corporation Improvement Act of 1991.

The Employment Act of 1946 and the Full Employment and Balanced Growth Act of 1978 (the latter sometimes called the Humphrey-Hawkins Act after its original sponsors) were passed by Congress to define and clarify the objectives of national economic policy. These objectives include economic growth in line with the economy's potential to expand; a high level of employment; stable prices; and moderate long-term interest rates. …

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