What exactly does Federal Reserve do?

A country’s economy can be compared to a chariot driven by two different horses - the government and the central bank.

While the government is involved in giving broader push to economy, the central bank takes the responsibility (which may, at times, become tricky) of ensuring growth, maintaining inflation and main foreign exchange reserves.

When it comes to the central bank, the growth versus inflation paradigm is one of the most difficult ones. While the economically right governments focus on the economy’s growth, the central bank needs to make sure that the interest rates are under control. Now this leads to a dilemma and oftentimes, a clash between the government and the central bank. Lowering interest rates makes credit cheaper. Once the credit is cheap, it flows towards the economy, revving up growth, in the process. However, the cheaper credit puts more money into hands of people. Hence, it may lead to unnecessary inflation as people end up buying more than they can. This makes decisions tricky for the central banks. And we have seen the same scenario playing out in the case of the US and India in the past three years.

What is a central bank?

A central bank, in short, is a non-market-based or even anti-competitive institution. It is a financial institution that has control over the production and distribution of money and credit for a particular geography. This control comes through the virtue of acts/laws prevailing in that country. Globally, central banks are mainly tasked with the monetary policy of the country and the regulation of member banks.

On the operational basis, some of the central banks are nationalised. However, many central banks are not government agencies. Such central banks are often touted as being politically independent. Even though, it is not a government agency, a central bank enjoys the privileges that are established and protected by law.

What is Federal Reserve?

The American central bank is known as the Federal Reserve, famously known as the Fed. It is arguably the most powerful financial institution in the country. The Fed is made up of 12 regional Federal Reserve Banks – with each Fed owning the responsibility of a particular geographic area in the country. This network of the 12 Feds is the reason why at times, it is known as the Federal Reserve System. These 12 Feds are based in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

After the panic created by various economic crises of the nineteenth century, the US Congress moved to establish the Fed in 1913. The Fed is seen as an independent agency since its decisions do not need to have a ratification by the president or anyone else from White House. Despite being fairly independent, the Fed is still subject to Congressional oversight and is supposed to work within the government’s economic and fiscal policy objectives.

What are the duties of the Fed?

The Fed has almost similar responsibility as any other central bank.

The agency’s most important function is to conduct a national monetary policy by influencing monetary and credit conditions in the US through decisions on bank rates. Among the macros, it is also tasked to ensure maximum employment in the economy, stable prices, and moderate term interest rates.

Then comes its supervisory role, as every central bank is tasked with supervising and regulating the banking institutions with its geography. So, the central bank is also tasked to ensure the safety of the banking and financial system and to protect consumers’ rights in the sector. Hence, the Fed supervises all the banks in US. Along with supervising function, it is also tasked with maintaining the financial system’s stability and containing the systemic risk – which at times can become very tricky. It also operates as a sort of bank to the government – at times. To maintain stability, the central bank, or any other central bank is also tasked with issuance of the government securities – in a bid to maintain right money flow into market.


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