Federal Reserve System


Federal Reserve System
a U.S. federal banking system that is under the control of a central board of governors (Federal Reserve Board) with a central bank (Federal Reserve Bank) in each of 12 districts and that has wide powers in controlling credit and the flow of money as well as in performing other functions, as regulating and supervising its member banks.

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U.S. central bank system consisting of 12 Federal Reserve districts with a Reserve bank in the principal commercial city of each district.

The system is supervised by a board of governors in Washington, D.C., as well as by various advisory councils and committees. As a result of the Federal Reserve Act of 1913, all national banks are required to join the system; state banks may join if they meet membership qualifications. The Federal Reserve is responsible for monetary policy. The original act set fixed reserve requirements for the U.S. fractional reserve banking system. It allowed each district bank to determine its discount rate, the rate it charged on loans to member banks. The modern Federal Reserve resulted from the Federal Reserve Act of 1935, which allowed the board to determine reserve requirements within defined limits. It became responsible for approving the discount rates of the district banks. Most importantly, the act created the Federal Reserve Open Market Committee, which is responsible for conducting operations in financial markets that increase or decrease the amount of reserves in the system. If the Federal Reserve wants to ease monetary policy, it will use open market operations and increase the amount of reserves through the purchase of financial assets. Conversely, it can tighten monetary policy through the sale of financial assets.

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▪ United States banking
      central banking authority of the United States. It acts as a fiscal agent for the U.S. government, is custodian of the reserve accounts of commercial banks (commercial bank), makes loans to commercial banks, and oversees the supply of currency, including coin, in coordination with the U.S. Mint. The system was created by the Federal Reserve Act, which Pres. Woodrow Wilson (Wilson, Woodrow) signed into law on Dec. 23, 1913. It consists of the Board of Governors of the Federal Reserve System, the 12 Federal Reserve banks, the Federal Open Market Committee, the Federal Advisory Council, and, since 1976, a Consumer Advisory Council; there are several thousand member banks.

      The seven-member Board of Governors of the Federal Reserve System determines the reserve requirements of the member banks within statutory limits, reviews and determines the discount rates (discount rate) established by the 12 Federal Reserve banks, and reviews the budgets of the reserve banks. The Chairman of the Board of Governors is appointed to a four-year term by the president of the United States.

      A Federal Reserve bank is a privately owned corporation established pursuant to the Federal Reserve Act to serve the public interest; it is governed by a board of nine directors, six of whom are elected by the member banks and three of whom are appointed by the Board of Governors of the Federal Reserve System. The 12 Federal Reserve banks are located in Boston; New York City; Philadelphia; Chicago; San Francisco; Cleveland, Ohio; Richmond, Virginia; Atlanta, Georgia; St. Louis, Missouri; Minneapolis, Minnesota; Kansas City, Missouri; and Dallas, Texas.

      The 12-member Federal Open Market Committee, consisting of the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four members elected by the Federal Reserve banks, is responsible for the determination of Federal Reserve bank policy to encourage long-term objectives of price stability (i.e., controlling inflation through the adjustment of interest rates) and economic growth. The Federal Advisory Council, whose role is purely advisory, consists of one representative from each of the 12 Federal Reserve districts.

      The Federal Reserve System exercises its regulatory powers in several ways, the most important of which may be classified as instruments of direct or indirect control. One form of direct control can be exercised by adjusting the legal reserve ratio—i.e., the proportion of its deposits that a member bank must hold in its reserve account—thus increasing or reducing the amount of new loans that the commercial banks can make. Because loans give rise to new deposits, the potential money supply is, in this way, expanded or reduced.

      The money supply may also be influenced through manipulation of the discount (discount rate) rate, which is the rate of interest charged by Federal Reserve banks on short-term secured loans to member banks. Since these loans are typically sought by banks to maintain reserves at their required level, an increase in the cost of such loans has an effect similar to that of increasing the reserve requirement.

      The classic method of indirect control is through open-market operations (open-market operation), first widely used in the 1920s and now employed daily to make small adjustments in the market. Federal Reserve bank sales or purchases of securities on the open market tend to reduce or increase the size of commercial-bank reserves; e.g., when the Federal Reserve sells securities, the purchasers pay for them with checks drawn on their deposits, thereby reducing the reserves of the banks on which the checks are drawn.

      The three instruments of control described here have been conceded to be more effective in preventing inflation in times of high economic activity than in bringing about revival from a period of depression. A supplemental control occasionally used by the Federal Reserve Board is that of changing the margin requirements involved in the purchase of securities.

      The Federal Reserve has broad supervisory and regulatory authority over state-chartered banks and bank holding companies, as well as foreign banks operating in the United States. It is also involved in maintaining the credit rights of consumers. One of the longest chairmanships of the Federal Reserve Board was held by Alan Greenspan (Greenspan, Alan), who took office in August 1987 and held the post until January 2006.

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Universalium. 2010.

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