History of the Federal Reserve System

For nearly 150 years, the U.S. States operated without a central banking system. According to the Washington Post, this set the stage for repeated financial panics. Unable to create money to meet demands, banks failed whenever customers withdrew more cash than they had on hand. Each bank failure sent people rushing to withdraw their money from other banks, creating a vicious cycle of financial catastrophes that eroded public trust. To strengthen the country’s financial house and restore the public’s faith in financial institutions, Congress established the Federal Reserve System in 1913. Commonly known as the Fed, it’s responsible for implementing the U.S.’s monetary policy, ensuring a healthy rate of growth of the nation’s money supply by adjusting interest rates and banking rules.

The Board of Governors of the Federal Reserve

The Board of Governors, also known as the Federal Reserve Board, leads the Fed. Comprised of seven members who are appointed by the president and confirmed by the Senate for 14 year staggered terms, the board is headed by a chairman and vice chairman, who are appointed to four year terms. Janet Yellen, the current chair, is the first woman to hold the position.

The Board is responsible for guiding the nation’s monetary policy, evaluating domestic and international economic factors, overseeing the nation’s payment system, and managing certain consumer protections regulations. It supervises the financial services industry, sets reserve requirements for banks, approves rate changes, and participates in the Federal Open Market Committee, according to the Federal Reserve Education website. The Board funds its activities by assessing the Federal Reserve Banks, directing any excess income to the U.S. Treasury.

Federal Open Market Committee (FOMC)

The Federal Open Market Committee is the Fed’s policy-making branch. Its voting members include the seven members of the Board of Governors and the president of the Federal Reserve Bank of New York, as well as the presidents of four other Reserve Banks who serve rotating one year terms. While the presidents of the remaining Reserve Banks do not vote, they participate in policy discussions, assisting the FOMC in making critical decisions regarding interest rates and other financial issues.

Related Resource: How the Federal Reserve Affects the Economy

The Federal Reserve System and Banks

Based in major cities scattered throughout the country, 12 Federal Reserve Banks act as banker’s banks by supervising the commercial banks in their region, storing currency, processing payments, and selling government securities. They also serve the Treasury by processing payments, assisting with cash management, and managing investments. In addition, Reserve Banks conduct economic research, providing vital information that informs the Board of Governors and the FOMC.

Roughly 40 percent of U.S. banks are members of the Fed. National banks are required to be member banks; state banks may join if they meet the necessary criteria. Financial institutions that are not members are still required to follow the Fed’s regulations and have access to the Fed’s payment services.

The Federal Reserve System is designed to provide financial stability through analysis and control of the nation’s monetary policies. Understanding what the Federal Reserve System is and how its decisions influence the economy is vital to comprehending how the U.S. economy functions.