Unless you’re an accountant or finance major, the inner workings of the Federal Reserve probably won’t cross your mind on a regular basis. Even if you’re not thinking about it, the Federal Reserve affects your day-to-day life more than you realize.
And with the latest COVID-19 news about interest rates being cut, you should know what it’s all about.
As America’s central bank, the Federal Reserve holds incredible power over everything from mortgage interest rates to stock prices… and everything in between. It’s important to understand how this government body works and what it means for your financial future.
What Is the Federal Reserve?
The Federal Reserve, more commonly known as the “Fed,” is our country’s central banking system. In the simplest terms, the Fed is responsible for keeping our intricate financial systems safe, which in turn keeps our economy as stable as possible.
Three entities work in unison to create the Federal Reserve:
- Twelve Federal Reserve banks around the country. These banks handle administrative tasks that keep the wheels turning
- The Federal Reserve Board of Governors, which consists of seven board members that oversee the entire system
- The Federal Open Market Committee (FOMC), which is responsible for setting up monetary policies. This committee is run by five Reserve Bank presidents and all seven Board of Governors members
Combined together, these three entities essentially control the banking systems that define the United States.
What Does the Fed Do?
You could spend months or even years learning about the specific responsibilities of the Federal Reserve. Overall, the Fed’s functions can be broken down into four core tasks.
1. The Fed Regulates Banks
Think of how many banks you pass each day on your way to work- dozens, probably! With tens of thousands of banks sprinkled across the United States, it’s the Fed’s duty to regulate such a massive number of financial institutions to maintain large scale stability and consistency.
To do this, the Board of Governors sets guidelines that banks must follow. These guidelines define policies, regulations, and supervision requirements. Each of the 12 Reserve Banks also handles a group of member banks to monitor their complicity with essential regulations.
2. The Fed Provides Payment Services
If you go to the bank to withdraw $1,000, you expect your bank to have that cash on hand. The Fed supports these types of payment services by keeping a sufficient amount of currency in operation, processing electronic payments, and transacting Social Security and government payroll checks. Without the Fed, payment services would be a free-for-all.
3. The Fed Sets Broad Monetary Policy
All monetary policies have two goals in common: high employment and low inflation. The Fed uses these two goals to shape its policy decisions. If inflation seems imminent, the Federal Reserve makes strategic changes to offset the rate of inflation and keep the economy calm.
4. The Fed Ensures Financial Stability
It’s easy to see how the Fed’s careful monetary policies, payment services, and bank regulations culminate to create financial stability.
How the Federal Reserve Impacts You
The Federal Reserve impacts your life every single day for the simple (yet utterly complex) fact that it’s responsible for keeping inflation low and employment high. Imagine how different your life would be if milk costs $9.50 a gallon and a third of your community was laid off!
More specifically, the Fed influences your financial life by setting the federal interest rate. Higher interest rates trickle down to create higher mortgage, credit card, and auto loan interest rates as well. This usually translates into slower home sales.
When the Fed lowers the interest rate, on the other hand, consumers are eager to take advantage of borrowing money and making big purchases.
Overall, the Federal Reserve’s decisions define your consumer choices, retirement savings, and job security more than you ever realized!