The FED, a privately-owned federal reserve whose goal is to maintain economic growth in the United States, is the most powerful central bank in the world.
Any investor who follows financial news closely will notice the US Federal Reserve regularly making headlines. Indeed, the slightest decision of this institution, especially concerning the variation of interest rates, is eagerly awaited by traders. The FED has a great deal of power over the financial markets, not only in the US, but also across the world.
What is the FED ? How is it organized and how does it work ? What are the aims of the FED ? What are the tools at its disposal ? What does the FED actually do ?
Here is a complete summary of what you need to know about the US Central Bank to understand how it is organized and what it can do.
FED, for Federal Reserve System, refers to the Central Bank of the United States of America, also known as the Federal Reserve. It was created on December 23, 1913. Following several banking crises at the beginning of the 20th century, including the very first crisis of this type in the United States in 1907, Congress sealed its establishment via the Federal Reserve Act. Like the European Central Bank (ECB), the Federal Reserve is independent of political power. Its objective is to create a positive economic dynamic in the United States and to generate economic growth, while fighting inflation.
The FED's monetary policy has been guided by three main objectives since its creation : full employment, price stability, and moderate long-term interest rates. In addition, the U.S. central bank is responsible for regulating the U.S. banking system, as well as maintaining the stability of the financial system. This last role was widely observed during the subprime crisis of 2007-2008. Thus, the FED is designated as the "lender of last resort" by Congress, and has been since its creation.
The U.S. central bank is organized in the same way today as when it was founded in 1913. It is headed by a Board of Governors, which has 7 members, including the Chairman of the Board. The other six members must come from different geographical areas and economic sectors. Thus, only one member of the Board can be the President of a Federal Bank. The Chairman and Vice Chairman of the Board of Governors are appointed for a term of four years each by the President of the United States himself and confirmed by the Senate. Jerome Powell is the current Chairman of the FED. The Board of Governors is responsible for regulating the banking system, in close cooperation with other FED committees. It sets the rules for the central bank's reserves, as well as the regulations for banking activity throughout the country. Finally, the Board regularly monitors the missions affiliated with the 12 US Federal Banks.
The seven members of the Board of Governors also sit on the FOMC (Federal Open Market Committee). Composed of 12 members in total, including five Federal Bank presidents who take turns sitting on it for a year, the committee defines US monetary policy. It meets every 6 weeks, i.e. about 8 times a year, and publishes reports, known as "minutes", after each meeting. Unlike the ECB and the majority of central banks in the world, the FED is a private institution, owned by the other US Federal Banks. It has 12 regional branches in the country's major cities, the first three of which are New York, San Francisco and Chicago. However, the FED remains closely regulated by the federal government and Congress.
In order to act on US monetary policy, the FED has three main tools :
In 2008-2009, following the subprime crisis, which was catastrophic for American banks, the FED implemented a policy of quantitative easing (QE). In a first phase, the Federal Reserve organized the purchase of a huge quantity of "rotten" assets held by the American banks in bankruptcy, i.e purchases estimated at nearly 1700 billion dollars. In a second phase, two other programs were set up to finance the public deficit. First, the FED repurchased about $1,000 billion worth of US Treasury bonds, then nearly $85 billion per month. This unconventional policy proved to be very effective, as it significantly lowered long-term interest rates and the country's unemployment rate.
As a century-old institution, the FED guides U.S. monetary policy by varying its interest rates, which has a direct impact on the U.S. economy and markets. However, the FED's decisions also have a major impact on financial markets around the world. It is therefore in the best interest of savvy investors to monitor it closely!
