Making Sense of the Federal Reserve Video
Making Sense of the Federal Reserve
Hi, I’m Penny, your personal tour guide. I’m here to introduce you to one of the most complex but effective institutions in the United States—the Federal Reserve.
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Hi, I’m Penny, your personal tour guide to the Federal Reserve. I’m here to introduce you to one of the most complex but effective institutions in the United States. But don’t worry, I’ll explain it all in plain English. Here is a road map of where we’re going. Together, we’ll walk through the Federal Reserve System, literally. And along the way, I’ll show you just what goes on around here and why it’s important. By the end of this tour you, too, will be able to explain the Federal Reserve in plain English.
As you can see, there’s a lot going on around the Fed, but keep in mind that the whole is really just the sum of the parts. Basically, the Federal Reserve is made up of three parts: the Board of Governors, that’s the building in the middle; the reserve banks, those are the 12 other buildings; and the Federal Open Market Committee. The complex design of these three parts is actually tied to how the Fed was created in the first place. To understand this structure better, let’s first step back about 100 years.
You’ve probably heard of the bank failures that occurred during the late 1800s and early 1900s. Back then, the failure of one bank often had a domino effect in which customers of other banks rushed to withdraw funds from their own banks. These banking panics wreaked havoc even on financially sound banks and sometimes paved the way to serious widespread economic recessions.
When Congress wrote the Federal Reserve Act in 1913, one objective of the Fed was to help banks acquire emergency cash reserves to meet such panic withdrawals so that the shortage of funds at one bank didn’t disrupt the entire banking system. This function would go a long way in establishing confidence in the banking system and more stability in the economy overall.
Another goal of the Fed was to make it easier and faster to make payments, especially between different parts of the country. To achieve these goals, the Fed, then and now, combined central national authority through the Board of Governors. Remember that on the map? With a healthy dose of regional independence through the reserve banks.
A third entity, the Federal Open Market Committee, brings together the expertise of the first two in setting the nation’s monetary policy. OK, that was a mouthful. Let me see if I can make better sense of it. Let’s take a walk through some of the places that make up the Fed, where you can see firsthand what we do.
I’m here now in Washington, D.C. Behind me is the Board of Governors, which is a U.S. government agency. The board has seven members, called governors, who are appointed by the U.S. president and confirmed by the U.S. Senate. One thing the governors do is write regulations to make commercial banks financially sound, which help make the nation economically strong.
It’s the governors’ jobs, along with economists and support staff, to study trends in the economy and to help forecast the country’s future economic direction. The governors also oversee those 12 reserve banks I showed you earlier. One important responsibility of the governors is participating on the Federal Open Market Committee, or FOMC.
Speaking of the FOMC, the meeting room is right next door. Let’s take a peek inside. I think a meeting is just wrapping up. Looks like we’re right on time. Straight ahead is the FOMC, the Fed’s chief body for monetary policymaking. Here, the seven governors from the Board of Governors meet with the presidents of the 12 reserve banks about eight times a year to discuss the current state of the economy and how to promote maximum employment and stable prices.
While everyone here participates in the discussion, only the voting members actually vote on any actions that the FOMC can take to influence monetary policy. Oh, and when I say voting members, I mean the seven board governors plus the president of the Federal Reserve Bank of New York and four other reserve bank presidents who serve on a rotating basis.
As we’ve just seen, each FOMC meeting ends with a vote on actions that will affect key interest rates, which then influence consumers’ and businesses’ spending and investment decisions. We’ll talk about this more in a minute. Before we do that though, let’s follow this reserve bank president back to the office to see what goes on there. Buckle up, we’re headed west.
In all, there are 12 districts in the Federal Reserve, and each is served by a regional reserve bank. Many also have one or more branches. As we’ll see, reserve banks have three main responsibilities: providing financial services, contributing to monetary policy and supervising commercial banks. Don’t worry if you didn’t catch that the first time through. We’ll take a look at each of these activities one by one.
First, let’s head to the financial services area and see why a reserve bank is often called the banker’s bank. This floor is busy around the clock, which shouldn’t surprise you. This is where the Fed’s task of providing a safe and efficient method for transferring money throughout the banking system takes place. Every day, banks deposit billions of dollars at the Fed in cash, checks, wire transfers or some other form of electronic payment for many of the same reasons we consumers use a bank.
In addition, reserve banks offer payment services to all financial institutions in the United States, no matter what their size or location. For example, that fast-paced clicking sound you hear is a high-speed machine that sorts thousands of pieces of currency every minute and checks for counterfeit bills. It also shreds old bills and where places them with new ones. The cash has been delivered to banks that need it.
And over there, through the glass, you can see the computers that transfer money electronically from one bank to another. Companies offer these services as well, but the Fed is a primary player in the business. By the way, even though the Fed competes with other businesses in the financial services it provides, the Fed stays in the marketplace primarily to promote competition, innovation and overall efficiency.
Besides serving commercial banks, reserve banks also serve as banks for the U.S. government. We maintain accounts for the U.S. Treasury, process government checks, and assist the Treasury in issuing and redeeming securities. There’s plenty more information about this on our website. It’s getting noisy on this floor, let’s go visit the research department where it’s a little quieter.
As you might guess, one of the most important jobs at the Fed is to help keep our economy healthy. We do this by conducting monetary policy. This isn’t easy to explain, but let me start by telling you what the economists do. Economists at the reserve banks are experts on different aspects of our national economy. These economists contribute to a broad exchange of ideas across the Federal Reserve System.
If you hang out in this department for a while, you’ll notice that economists often hold firmly to their individual opinions and are known to debate their points of view with one another. Despite their varying perspectives, most economists agree, though, that the economy performs well when inflation is low and stable. As a result, low inflation is a long-term goal of the Fed.
So what do the economists do with their research? A lot of publishing and a lot of public speaking before all types of audiences. But their most important job is to prepare their reserve bank president for the FOMC meetings we poked our heads in on earlier. At the FOMC meetings, members together set a target range for its policy interest rate called the federal funds rate, which is the interest rate on overnight loans between banks.
This rate influences other interest rates, like those for mortgage loans, and greatly affects the direction of the economy. To ensure the federal funds rate stays within the FOMC’s target range, the Fed has monetary policy tools, such as the interest rate it pays to banks on their reserve balances, that can be used to steer the federal funds rate into the FOMC’s target range.
Speaking of interest rates in the banking system, let’s tag along with this bank examiner heading out to a commercial bank. To see what examiners do, you have to hit the road. As you might recall, Congress created the Federal Reserve to foster safe, sound and competitive practices in the nation’s banking system. To accomplish this, the Fed both regulates the banking system and supervises certain types of financial institutions.
In case you’re wondering, these types include state-chartered member banks, bank holding companies, which are the companies that own banks, and international organizations that do banking business in the United States. There are other types of banks that are supervised by other regulators. What’s the difference between regulation and supervision?
Bank regulation refers to the written rules that define what is acceptable behavior for financial institutions. The Board of Governors in Washington, D.C., takes care of this responsibility. Supervision refers to the enforcement of these rules, which is carried out by staff at the 12 reserve banks.
Fed examiners, like those here, visit commercial banks and look over the bank’s financial statements to evaluate the quality of assets, internal controls and ability to manage risk. Why do you care? Because you’ve got money in this bank. The examiners’ job is to make sure your money is safe and sound. Examiners also review a bank’s performance in complying with federal and state laws.
At the end of an on-site review, Fed examiners issue the bank a rating that reflects whether the institution is in good shape or whether it has weaknesses that require corrective action and close monitoring. One of the most important ways that the Fed ensures safety and soundness of the banking system is by helping banks respond to all kinds of crises.
One way the Fed does this is by making short-term loans to banks through its discount window. This not only helps individual banks and their customers, but also ensures that a shortage of funds at one institution does not disrupt the flow of money and credit in the entire banking system.
Well, here we are at the end of our journey. As promised, I’ve introduced you to the three big stops on the Fed tour: the Board of Governors, the FOMC and the 12 reserve banks. I’ve also described our three main responsibilities: providing financial services, conducting monetary policy and supervising banks.
I hope my plain-English style has helped you make sense of the complex, yet effective, design of the Federal Reserve System and how we contribute to a healthy economy. And hey, if you want more information, visit FederalReserveEducation.org and tell them Penny sent you.
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