The Federal Reserve System serves as the central bank of the United States. The interest rate that the Fed targets influences all sorts of financial activity in the country. Read on to learn more about the Fed’s structure and its purpose.
If you carry card debt, the interest rate on the debt tends to vary from time to time.
That’s because most credit card issuers charge you a rate that’s tied to the prime rate, which varies based on the interest rate that the Federal Reserve targets.
What is the Federal Reserve?
The Federal Reserve System serves as the central bank of the United States. The interest rate that the Fed targets influences all sorts of financial activity in the country.
The Federal Reserve Act of 1913 set up the Fed to provide financial stability for the U.S. economy. It is an independent agency of the government, but it is accountable to Congress, as well as the public.
The Fed is led by its Board of Governors, comprising seven governors who are appointed by the president and then confirmed by the Senate. The law requires the president to appoint governors who make for “a fair representation of the financial, agricultural, industrial and geographical divisions of the country.” These governors serve 14-year terms, with one term ending every two years. That way, no one president can influence the makeup of the board.
The Federal Open Market Committee and 12 regional Federal Reserve Banks are also part of the Fed system. Jerome H. Powell is the current chair of the Fed’s Board of Governors, and is also the FOMC chair. He has served on the Fed’s Board of Governors since 2012, and was appointed Fed chair in 2018 for a four-year term.
The Fed is set up to make sure that it is not subject to political pressure as it serves its functions. The Fed is self-funded and makes money through interest it earns on its government securities holdings and loans to banks, as well as fees it charges banks. The central bank provides a report to Congress and also undergoes an annual audit to make for accountability.
What does the Fed do?the Fed’s work is geared toward ensuring the smooth operation of the U.S. economy. To this end, the main functions of the Fed include:
- Conducting monetary policy in a manner that makes for full employment, price stability and inflation that, in a Goldilocks-like scenario, runs just right – neither too high nor too low.
- Promoting financial system stability and watching for any risk to the overall economy by actively monitoring developments in the U.S. and globally.
- Promoting the financial soundness of financial institutions and watching for any impact they might have individually on the overall financial system.
- Providing services to the government and the banking system to enable U.S. dollar transactions and payments so as to enable the smooth functioning of the payment and settlement system
- Enabling consumer protection and fostering community development through various means, including the supervision of consumer-focused laws and regulations.
See related: What is the CFPB?
Where are the regional Fed banks located?
There is a network of 12 Federal Reserve Banks, with 24 branches, spread across the U.S. so that the Fed can gauge the economy of the country overall. These banks also provide services to commercial banks – such as storing money and processing checks and electronic payments – and are sometimes referred to as banks for bankers. They also provide services to the U.S. Treasury.
The 12 banks are each separately incorporated, as mandated by the Federal Reserve Act, with a nine-member board of directors. Each board appoints a president and first vice president for its regional bank, with each appointment having to be approved by the Fed’s Board of Governors.
Each bank has its pulse on its regional economy and feeds it to the FOMC and the Fed’s Board of Governors to enable better decision-making.
The 12 Federal Reserve Banks are located in:
- New York
- Richmond, Virginia
- St. Louis
- Kansas City, Missouri
- San Francisco
How does the Fed engage in monetary policy?
Monetary policy involves the various moves the Fed makes to influence how easy, or difficult, it is to access credit and money to achieve its goal of growth in a noninflationary environment. The FOMC is responsible for charting the Fed’s monetary policy. It is made up of the Fed’s seven governors and five of its 12 Reserve Bank presidents.
The chair of the Fed Board of Governors also serves as FOMC chair. The president of the New York Fed always serves as vice president of the FOMC and has a permanent vote. The four remaining voting positions on the FOMC are rotated among the other Reserve Bank presidents. Nonvoting Reserve Bank presidents also attend FOMC meetings to provide their input.
The FOMC typically meets eight times a year in Washington, D.C., to assess the economic situation and take monetary policy decisions. Banks maintain balances with Federal Reserve Banks as a safeguard for their deposits, and also to engage in transactions.
Banks with an excess amount of such reserves than they are required to hold can lend money to other banks at an interest rate called the Fed funds rate. The FOMC sets a target for this so-called fed funds rate depending on whether it wants to boost or slow down the economy. The FOMC uses a variety of tools to get its desired monetary policy outcomes. They include:
- The purchase and sale of U.S. Treasuries and federal agency securities. When the Fed wants to stimulate the economy, it buys such securities, thereby adding to the money supply. And when it wants to slow it down it sells such securities, so that money is sucked up and less available.
- The discount rate that Reserve Banks charge commercial banks and other depository institutions to make short-term loans to them. This rate has to be approved by the Fed’s Board of Governors.
- Setting requirements for the amount of reserve funds that banks need to hold with Reserve Banks against their deposits.
Impact on credit card interest rates
The Fed’s monetary policy actions filter down to the entire economy and influence other short- and long-term interest rates and also foreign exchange rates. By influencing the availability of money and credit available in the economy, the Fed influences prices of various goods and services, and also employment.
Ultimately, the Fed’s actions also trickle down to the interest rates you pay on your credit cards. Credit card issuers typically tie their variable interest rates to the so-called prime rate, by adding a margin to it. The prime rate varies with the Fed’s target fed funds rate and tends to move up or down with it.