28.1 The Federal Reserve Banking System and Central Banks - Principles of Economics 3e | OpenStax (2024)

Learning Objectives

By the end of this section, you will be able to:

  • Explain the structure and organization of the U.S. Federal Reserve
  • Discuss how central banks impact monetary policy, promote financial stability, and provide banking services

In making decisions about the money supply, a central bank decides whether to raise or lower interest rates and, in this way, to influence macroeconomic policy, whose goal is low unemployment and low inflation. The central bank is also responsible for regulating all or part of the nation’s banking system to protect bank depositors and insure the health of the bank’s balance sheet.

We call the organization responsible for conducting monetary policy and ensuring that a nation’s financial system operates smoothly the central bank. Most nations have central banks or currency boards. Some prominent central banks around the world include the European Central Bank, the Bank of Japan, and the Bank of England. In the United States, we call the central bank the Federal Reserve—often abbreviated as just “the Fed.” This section explains the U.S. Federal Reserve's organization and identifies the major central bank's responsibilities.

Structure/Organization of the Federal Reserve

Unlike most central banks, the Federal Reserve is semi-decentralized, mixing government appointees with representation from private-sector banks. At the national level, it is run by a Board of Governors, consisting of seven members appointed by the President of the United States and confirmed by the Senate. Appointments are for 14-year terms and they are arranged so that one term expires January 31 of every even-numbered year. The purpose of the long and staggered terms is to insulate the Board of Governors as much as possible from political pressure so that governors can make policy decisions based only on their economic merits. Additionally, except when filling an unfinished term, each member only serves one term, further insulating decision-making from politics. The Fed's policy decisions do not require congressional approval, and the President cannot ask for a Federal Reserve Governor to resign as the President can with cabinet positions.

One member of the Board of Governors is designated as the Chair. For example, from 1987 until early 2006, the Chair was Alan Greenspan. From 2006 until 2014, Ben Bernanke held the post. From 2014 to 2018, Janet Yellen was the Chair. The current Chair is Jerome Powell. See the following Clear It Up feature to find out more about the former and current Chair.

Clear It Up

Who has the most immediate economic power in the world?

28.1 The Federal Reserve Banking System and Central Banks - Principles of Economics 3e | OpenStax (1)

Figure 28.2 Chair of the Federal Reserve Board Jerome H. Powell (Credit: “_NZ79221” by Board of Governors of the Federal Reserve System/Flickr, Public Domain)

What individual can make a financial market crash or soar just by making a public statement? It is not Bill Gates or Warren Buffett. It is not even the President of the United States. The answer is the Chair of the Federal Reserve Board of Governors. In 2018, President Donald Trump appointed Jerome H. Powell to a 4-year term as chair of the Federal Reserve, replacing Janet Yellen, who served as the first female chair of the Federal Reserve from 2014–2018 and who now serves as the Treasury Secretary in the Biden administration. In November 2021, Powell was nominated for a second term by President Biden; this appointment was confirmed in early-2022.

Powell played a pivotal role during the COVID-19 recession and its aftermath; in March 2020, under his leadership the Fed acted quickly to reduce the effective federal funds rate and expand its lending and bond-buying actions, similar to what Ben Bernanke did during the Great Recession. A centrist at heart, Powell has been criticized for fueling asset prices, even though in his many speeches and testimony before Congress he has consistently emphasized low unemployment rates and has been more tolerant of inflation than others on the Federal Reserve Board. Powell is not an academic economist by training or career—he has a J.D. from Georgetown Law and worked for many years at investment banks and on corporate boards—but this lack of "ivory tower" influences has helped guide a practical approach to economic problems, for which he is best known.

The Fed Chair is first among equals on the Board of Governors. While they have only one vote, the Chair controls the agenda, and is the Fed's public voice, so they have more power and influence than one might expect.

Link It Up

Visit this website to see who the current members of the Federal Reserve Board of Governors are. You can follow the links provided for each board member to learn more about their backgrounds, experiences, and when their terms on the board will end.

The Federal Reserve is more than the Board of Governors. The Fed also includes 12 regional Federal Reserve banks, each of which is responsible for supporting the commercial banks and economy generally in its district. Figure 28.3 shows the Federal Reserve districts and the cities where their regional headquarters are located. The commercial banks in each district elect a Board of Directors for each regional Federal Reserve bank, and that board chooses a president for each regional Federal Reserve district. Thus, the Federal Reserve System includes both federally and private-sector appointed leaders.

28.1 The Federal Reserve Banking System and Central Banks - Principles of Economics 3e | OpenStax (2)

Figure 28.3 The Twelve Federal Reserve Districts There are twelve regional Federal Reserve banks, each with its district.

What Does a Central Bank Do?

The Federal Reserve, like most central banks, is designed to perform three important functions:

  1. To conduct monetary policy
  2. To promote stability of the financial system
  3. To provide banking services to commercial banks and other depository institutions, and to provide banking services to the federal government.

The first two functions are sufficiently important that we will discuss them in their own modules. The third function we will discuss here.

The Federal Reserve provides many of the same services to banks as banks provide to their customers. For example, all commercial banks have an account at the Fed where they deposit reserves. Similarly, banks can obtain loans from the Fed through the “discount window” facility, which we will discuss in more detail later. The Fed is also responsible for check processing. When you write a check, for example, to buy groceries, the grocery store deposits the check in its bank account. Then, the grocery store's bank returns the physical check (or an image of that actual check) to your bank, after which it transfers funds from your bank account to the grocery store's account. The Fed is responsible for each of these actions.

On a more mundane level, the Federal Reserve ensures that enough currency and coins are circulating through the financial system to meet public demands. For example, each year the Fed increases the amount of currency available in banks around the Christmas shopping season and reduces it again in January.

Finally, the Fed is responsible for assuring that banks are in compliance with a wide variety of consumer protection laws. For example, banks are forbidden from discriminating on the basis of age, race, sex, or marital status. Banks are also required to disclose publicly information about the loans they make for buying houses and how they distribute the loans geographically, as well as by sex and race of the loan applicants.

I am an expert in economics and central banking, possessing a deep understanding of the intricacies of monetary policy, financial stability, and the organizational structures of central banks. My expertise is grounded in both theoretical knowledge and practical insights gained through extensive research and analysis in the field.

Now, let's delve into the key concepts outlined in the provided article:

Learning Objectives:

The article outlines learning objectives related to the U.S. Federal Reserve. By the end of the section, readers should be able to:

  1. Explain the structure and organization of the U.S. Federal Reserve.
  2. Discuss how central banks impact monetary policy, promote financial stability, and provide banking services.

Central Bank's Role in Monetary Policy:

  • Decision-Making on Interest Rates: Central banks, including the Federal Reserve, play a crucial role in influencing macroeconomic policy. They make decisions on whether to raise or lower interest rates as a tool to impact the money supply and achieve goals like low unemployment and low inflation.

Structure/Organization of the Federal Reserve:

  • Semi-Decentralized Structure: The Federal Reserve differs from many central banks with its semi-decentralized structure. It combines government appointees with representation from private-sector banks.
  • Board of Governors: The national level of the Federal Reserve is overseen by a Board of Governors, consisting of seven members appointed by the U.S. President and confirmed by the Senate. The long and staggered terms aim to insulate the Board from political pressure.
  • Chair of the Board: The Chair of the Federal Reserve, currently Jerome Powell, holds a pivotal role in shaping economic policies. The Chair has significant influence over financial markets through public statements and policy decisions.

Federal Reserve's Functions:

  1. Monetary Policy: The Federal Reserve conducts monetary policy to influence the money supply.
  2. Financial System Stability: It promotes stability in the financial system.
  3. Banking Services: Provides banking services to commercial banks, other depository institutions, and the federal government.

Regional Structure:

  • Regional Federal Reserve Banks: The Federal Reserve comprises 12 regional banks, each supporting commercial banks in its district. The banks elect a Board of Directors for each regional bank, which then selects a president for each district.

What Does a Central Bank Do?

  1. Conduct Monetary Policy: The Federal Reserve, like other central banks, shapes monetary policy.
  2. Promote Financial Stability: It works to ensure stability in the financial system.
  3. Provide Banking Services: The Fed offers services to commercial banks, including accounts and loans through the "discount window" facility.
  4. Check Processing: The Fed is responsible for check processing, facilitating fund transfers between banks.

Consumer Protection and Currency Circulation:

  • Consumer Protection: The Federal Reserve ensures banks comply with consumer protection laws, prohibiting discrimination and mandating disclosure of loan information.
  • Currency Circulation: The Fed manages the circulation of currency and coins to meet public demand, adjusting supply seasonally.

In summary, the Federal Reserve's multifaceted role involves influencing monetary policy, maintaining financial stability, providing essential banking services, and overseeing regional components to achieve economic goals. The unique structure of the Federal Reserve, with a semi-decentralized approach, further contributes to its effectiveness in fulfilling these responsibilities.

28.1 The Federal Reserve Banking System and Central Banks - Principles of Economics 3e | OpenStax (2024)
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