Wednesday, September 21, 2011

What Is the Federal Reserve Bank; and How Does It Work?

Today’s newspapers are full of references to economic news; and references to the Federal Reserve Bank are replete in those articles. But…many of us do not know what the Federal Reserve is and how it works. Here is a short primer:

The Federal Reserve is a bank that is established by Congress. It consists of the central bank of the United States. It includes a Board of Governors, 12 District Banks, 25 Branch Banks, and assorted committees. The most important of these committees is the Federal Open Market Committee, which directs monetary policy. The FOMC is made up of 12 voting members; eight of these members are political appointees of the President, and 4 are regional bank presidents.

The function of the Federal Reserve is to control monetary policy, which, in other words, is the supply of money for the country. The “Fed,” as it is called, puts money into our economy when recessions occur; and it takes money out of the economy when inflation is the problem. By doing these manipulations, the Fed is supposed to control overall prices and unemployment.

The Fed uses 3 mechanisms to control prices, inflation, and recession: The first is “open market operations,” which is the Fed’s option to buy or sell government bonds—by doing so, the Fed can either add to or subtract from the money supply in the country. The second is to manipulate the “discount rate,” which is the interest rate the Fed uses to loan money to other banks for them to lend the money to borrowers. The third method is to manipulate the “reserve requirements” of commercial banks, i.e., the amount of money the commercial banks are required to keep on hand to secure their deposits. By lowering or raising the reserve requirements the Fed can add to or subtract from the supply of money circulating in the economy.

If my readers are interested in learning more about economic principles and terms, I would suggest that they look at

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