Introduction to the Federal Reserve - Online Tutor, Practice Problems & Exam Prep

The Federal Reserve, established in 1913, serves as the Central Bank of the United States, primarily regulating banks and controlling the money supply through monetary policy. It consists of a Board of Governors with 7 members appointed by the president, and 12 regional Federal Reserve Banks. The Federal Open Market Committee (FOMC) plays a crucial role in adjusting the money supply via open market operations, influencing the federal funds rate and discount loans. The Fed acts as a lender of last resort, ensuring financial stability during banking crises, such as bank runs.

Organization of the Federal Reserve

Alright. So now I want to introduce you to the Federal Reserve and how it's composed. The Federal Reserve is the Central Bank of the United States. I want to make a quick note before we get into this. A lot of professors have a different amount of weight that they put on this topic. We're going to learn a lot about how the Federal Reserve is composed, how many people are involved in each certain thing, and how long their terms are. Some professors love to ask multiple choice questions about this, and this is just stuff you have to commit to memory. But a lot of them overlook it because they know it's just about remembering this and knowing the answer or not. So I'm putting this in here just in case you need to know it, but definitely double check with your professor and see how deep he is going to get into all of these details.

The Federal Reserve was created in 1913. The Central Bank of the United States was created in 1913 after a series of bank failures. What is a banking failure? Generally, it's when a bank doesn't have enough money to pay out its depositors. A bank run is when many depositors simultaneously decide to withdraw their money. Maybe they heard that the bank is in serious financial trouble and they want to get their money out immediately. So, everyone starts to hear this, and then it begins this kind of cycle effect, and everyone tries to withdraw. But what's the problem with that? The reserves. As we've learned about reserves, they don't hold all the deposits as reserves. They're loaning some of it out and if everyone comes to try and withdraw their money at the same time, it's not going to be there. This happened in 1913, and there was actually a bank panic in 1907, when many banks simultaneously experienced bank runs.

So, the Fed was created in response to this. Let's go ahead and talk about the organization of the Fed in this video. First thing is the Board of Governors. This is the highest body in the Fed, and there are 7 members on the Board of Governors. They are appointed by the President of the USA and are confirmed by the Senate. These governors are going to serve 14-year terms. The chairperson of the board is the leader of the Board of Governors and serves a 4-year term and may be reappointed by the President. At the time of filming this video, the chairperson was Janet Yellen. But I want you to double-check because if the chairperson at the point that I filmed this, they were already thinking about changing who the chairperson was. So definitely double check; you can even do a quick Google search and just type "Chairperson of the Fed" and just see who the current chairperson is.

The rest of the organization includes the Federal Reserve Banks. We have the Board of Governors that is the overseeing board, and then there are banks which are regional around the United States, with 12 different regional banks of the Fed located in major cities throughout the country. Each Federal Bank has its own board of directors and its own president.

The most important part of the Fed that we are going to be focusing on is the Federal Open Market Committee. This committee makes decisions to increase or decrease the money supply in the US. It is composed of all the members of the Board of Governors, 7 members, and 5 of the regional bank presidents. These 5 regional bank presidents rotate throughout the different meetings, over time. There are 12 total people in the Federal Open Market Committee, being 7 from the Board of Governors and 5 of the regional bank presidents. They meet approximately every 6 weeks to discuss monetary policy. We will be getting into a lot more about monetary policy in the upcoming videos.

Let's pause here real quick, and we'll discuss the role of the Fed in the next video.

Role of the Federal Reserve

Alright. So the Fed has 2 main roles in our financial system. First, is that they're going to regulate banks and ensure the health of the banking system. They want to make sure everything is running smoothly. And second, is controlling the quantity of money. Right? The quantity of money available, the money supply in the economy. Okay? And that's going to be through monetary policy. So let's start here with, the first bullet point, regulating banks. This is carried out, excuse me, carried out mainly by the regional Federal Reserve Banks where they're going to be regulating the banks in their region and the Fed is considered the lender of last resort. Okay? This is a key feature of the Fed is if things are going south, well, the Fed is expected to be able to make loans to these banks to make sure that they don't go under. Right? They're the lender of last resort.

And then we've got 3 different, definitions of loans that we're going to be dealing with in the upcoming topics. We're going to be dealing with discount loans. So these are loans made by the Fed to banks. So discount loans are by the Fed to banks. So banks go to the Fed and get a loan from the bank, and they're going to be at the discount rate. So the discount loans are at the discount rate. So it's the interest rate on discount loans, but we also have this other type of loan called the federal funds rate. And this is the interest rate banks give to other banks on overnight loans. So sometimes a bank might need some money, to meet their reserve requirements or something maybe, you know, their reserves are a little low. So they might borrow some money from another bank overnight just to fill in the gaps there. And that would be done at the federal funds rate. So, you can imagine this discount loan is the lowest rate. And this is just above it. Just above the discount. Okay? So these are loans, made from the Fed are going to be at the lowest possible rate. And then the federal funds rate is going to be just above the discount rate from one bank to the other bank on a short-term basis. Okay.

So the second role that we're going to be focused on a lot in this class is monetary policy. Okay? This is monetary policy and we're going to go into a lot of details about this in future videos. So this is controlling the quantity of money. The money supply in the economy using monetary policy. And this is carried out by the FOMC, that Federal Open Market Committee. And they're going to use open market operations which is what we're going to focus on mostly. They can change the discount policy, which is the discount rate and they can adjust reserve requirements. So this is the reserve ratio, required reserves. Right? The reserve ratio, so they can affect any of these and open market operations, this is the one we're going to be focusing on the most is buying and selling securities. Okay? So they're going to buy and sell securities to control the amount of money available in the public. Alright? So we'll get into that a lot more in future videos, but this is the role of why we have the Fed here in the US. Cool? Alright. Let's go ahead and pause and move on.

Here’s what students ask on this topic:

What is the Federal Reserve and why was it created?

The Federal Reserve, often referred to as the Fed, is the Central Bank of the United States, established in 1913. It was created in response to a series of bank failures, particularly the bank panic of 1907, where many banks experienced simultaneous bank runs. A bank run occurs when a large number of depositors withdraw their money simultaneously due to fears that the bank will become insolvent. The Fed was established to provide stability to the financial system, regulate banks, and act as a lender of last resort to prevent such crises from happening again.

How is the Federal Reserve structured?

The Federal Reserve is structured with a Board of Governors at its core, consisting of 7 members appointed by the President of the United States and confirmed by the Senate. These governors serve 14-year terms. The Board is led by a Chairperson, who serves a 4-year term and can be reappointed. Additionally, there are 12 regional Federal Reserve Banks located in major cities across the country, each with its own board of directors and president. The Federal Open Market Committee (FOMC), which includes the 7 Board members and 5 rotating regional bank presidents, is responsible for making key monetary policy decisions.

What are the main roles of the Federal Reserve?

The Federal Reserve has two main roles: regulating banks and controlling the money supply. It ensures the health of the banking system by overseeing and regulating banks, primarily through the regional Federal Reserve Banks. The Fed also acts as the lender of last resort, providing loans to banks in distress. The second role involves controlling the quantity of money in the economy through monetary policy, which is managed by the Federal Open Market Committee (FOMC). The FOMC uses tools like open market operations, adjusting the discount rate, and changing reserve requirements to influence the money supply.

What is the Federal Open Market Committee (FOMC) and what does it do?

The Federal Open Market Committee (FOMC) is a key component of the Federal Reserve responsible for overseeing the nation's open market operations and thus influencing the money supply. The FOMC is composed of the 7 members of the Board of Governors and 5 of the 12 regional Federal Reserve Bank presidents, who rotate their participation. The FOMC meets approximately every 6 weeks to discuss and set monetary policy, primarily through open market operations, which involve buying and selling government securities. These actions help control the federal funds rate and, consequently, the overall money supply in the economy.

What is the difference between the discount rate and the federal funds rate?

The discount rate is the interest rate charged by the Federal Reserve to banks for short-term loans obtained directly from the Fed. These loans are known as discount loans. The federal funds rate, on the other hand, is the interest rate at which banks lend to each other overnight to meet reserve requirements. The federal funds rate is typically slightly higher than the discount rate. Both rates are crucial tools in the Fed's monetary policy, influencing the availability and cost of credit in the economy.