Econ: Functions of the Federal Reserve

MonetaryPolicyThe Federal Reserve is the central bank of the United States and has three primary functions: financial services, supervision and regulation, and monetary policy.

The Federal Reserve Banks provide financial services to banks, credit unions, and savings and loans, much like those banks provide for their customers. These services include distributing and receiving cash and coin, collecting checks, and electronically transferring funds.

It’s up to the Fed to make sure there is enough money in circulation. Reserve Bank offices maintain cash and coin processing operations to accept deposits and distribute cash and coin to financial institutions. When cash and coin are deposited with the Reserve Banks, notes that are suspected of being counterfeit are separated from the rest and forwarded to the Secret Service. Notes that are too worn for recirculation are destroyed using a shredding machine. Each of the twelve Federal Reserve Banks is authorized by the Federal Reserve Act to issue currency. The notes are designed and printed by the Bureau of Engraving and Printing of the Department of the Treasury and are delivered to the Reserve Banks for circulation.

Federal Reserve Banks provide two types of electronic payment services; the automated clearinghouse service and wire transfers. The Automated Clearinghouse (ACH) is an electronic payment network through which banks send each other electronic credit and debit transfers. The Fedwire funds transfer system is a large-dollar electronic payment system owned and operated by the Federal Reserve Banks that transfers funds between financial institutions. Participants typically transfer large dollar, time-critical payments, to repay large loans or to settle real estate transactions. The majority of Fedwire transactions are initiated on-line and all transactions are completed in seconds. The Federal Reserve System operates a nationwide check clearing system that processes checks, drafts and similar items. When a bank receives deposits of checks drawn on other banks, it sends the checks for collection to a Federal Reserve Bank. For checks collected through the Federal Reserve Banks, the accounts of the collecting institutions are credited for the value of the checks deposited for collection and the accounts of the paying banks are debited for the value of checks presented for payment. Most checks are collected and settled within one business day.

Additionally, the Federal Reserve acts as a fiscal agent or bank to the federal government by providing financial services to the United States Department of Treasury and by selling and redeeming government securities such as Savings Bonds and Treasury bills. One of the core responsibilities of the Federal Reserve Banks is to serve as fiscal agent and depository for the United States government. In this role, the Reserve Banks act as the federal government’s bank and perform several services for the Treasury. These services include: maintaining accounts for U.S. Treasury, processing government checks, postal money orders and U.S. savings bonds, and collecting federal tax deposits.

The Federal Reserve System supervises and regulates a wide range of financial institutions and activities. The Federal Reserve works in conjunction with other federal and state authorities to ensure that financial institutions safely manage their operations and provide fair and equitable services to consumers. Bank examiners also gather information on trends in the financial industry, which helps the Federal Reserve System meet its other responsibilities, including determining monetary policy. Two major focuses of banking supervision and regulation are the safety and soundness of financial institutions and compliance with consumer protection laws. To measure the safety and soundness of a bank, an examiner performs an on-site examination review of the bank’s performance based on its management and financial condition, and its compliance with regulations. If consumers have a complaint about a financial institution they can contact the Federal Reserve. Together with the twelve Federal Reserve Banks, the Board of Governors can answer questions about banking practices and investigate complaints about specific banks under the Fed’s supervisory jurisdiction.

Monetary policy refers to what the Federal Reserve, the nation’s central bank, does to influence the amount of money and credit in the U.S. economy. The goals of monetary policy are to promote maximum employment, stable prices and moderate long-term interest rates. By implementing effective monetary policy, the Fed can maintain stable prices, thereby supporting conditions for long-term economic growth and maximum employment. The Federal Reserve’s three instruments of monetary policy are open market operations, the discount rate and reserve requirements.

Open market operations involve the buying and selling of government securities. The term “open market” means that the Fed doesn’t decide on its own which securities dealers it will do business with on a particular day. Rather, the choice emerges from an “open market” in which the various securities dealers that the Fed does business with – the primary dealers – compete on the basis of price. Open market operations are flexible, and thus, the most frequently used tool of monetary policy.

The discount rate is the interest rate charged by Federal Reserve Banks to depository institutions on short-term loans.

Reserve requirements are the portions of deposits that banks must maintain either in their vaults or on deposit at a Federal Reserve Bank.



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