What Is The Federal Reserve?

Vault’s Viewpoint

• The Federal Reserve system serves as the central bank of the United States.
• The Federal Reserve performs several functions, including managing U.S. monetary policy, keeping the U.S. financial system stable and advocating for consumer protection.
• Decisions made by the Federal Reserve can have a meaningful impact on personal finances, especially if you borrow money or save money with U.S. banks or credit unions.

What Is the Federal Reserve?

The Federal Reserve, or the Fed, is the central bank of the United States. It’s responsible for providing the country with a stable and safe financial system.

President Woodrow Wilson created the Federal Reserve in 1913 with the signing of the Federal Reserve Act. The act created a central banking system made up of the following three entities.

• Federal Reserve Board of Governors
• 12 Federal Reserve Banks
• The Federal Open Market Committee (FOMC)

What Is the Federal Reserve Bank and What Does It Do?

The Federal Reserve doesn’t have just one job to fulfill, but rather many. As the Fed works to provide the American people with a safe and stable financial system, its five primary responsibilities are as follows:

• Oversee U.S. Monetary Policy: The Fed takes action to encourage a variety of economic goals including steady prices, strong employment rates and moderate interest rates throughout the country.
• Contributes to a Stable Financial System: The Fed works to make sure U.S. consumers and businesses can count on a stable financial system that lets them access financing and save money without fear even during times of economic turmoil.
• Regulation: The Fed helps to monitor and regulate individual financial institutions, along with the effect those banks and credit unions have on the U.S. financial system.
• Provides Services:The Fed provides key payment and settlement system safety services to banks and the federal government to help support the banking system.
• Supports Consumer Protection: The Fed advocates for ongoing consumer protection and community development. This includes making sure the financial institutions it regulates comply with consumer protection laws and regulations.

Who Regulates the Federal Reserve?

The Federal Reserve is an independent government agency. But the institution does have some accountability to both Congress and the American people.

The Board of Governors is the governing body of the Federal Reserve System. The President nominates the seven members of the Board and the U.S. Senate must confirm the men and women who serve in these positions. The seven members of the Board of Governors also serve on the FOMC—the body of the Federal Reserve that sets monetary policy for the United States (including setting the federal funds rate).

What Is the Federal Funds Rate?

Before you can understand how the Federal Reserve may impact your personal finances, it’s important to become familiar with a term called the federal funds rate. The federal funds rate is a target interest rate range that U.S. commercial banks charge one another when lending excess reserves overnight. This interest rate doesn’t have a direct impact on what lenders charge consumers and businesses to borrow money. But when the federal funds rate increases or decreases, interest rates on financing products tend to follow suit.

During times of economic turmoil when unemployment rates surge, the Federal Reserve may take action and reduce the federal funds rate. This makes it more affordable for businesses (and consumers) to borrow money. As a result, economic growth may be more likely to occur, consumers are encouraged to spend more and businesses have the financial resources to hire more workers.

An example of this occurred recently during the COVID-19 pandemic. The Fed lowered the federal funds rate to a range of 0% to 0.25% in March 2020 to stimulate economic growth and encourage maximum employment.

Yet unemployment is not the only economic factor the Fed seeks to control. One of the Federal Reserve’s other primary goals is to keep the rate of inflation at around 2%.

When inflation rises above that rate, as it has over the last several years, the Federal Open Market Committee (FOMC) often raises the target range for the federal funds rate in an effort to bring prices back down. The Fed has raised interest rates 11 times since March 2022.

How Does the Federal Reserve Impact Your Finances?

The Federal Reserve has many important jobs. Yet it’s the Federal Reserve’s responsibility for managing U.S. monetary policy that often interests the public the most.

When the Fed dropped the target range for the federal funds rate to near 0% in response to the pandemic, it was less expensive for consumers to borrow money. Interest rates on a wide range of financing products were significantly lower than they had been in previous years. According to Freddie Mac, the average mortgage rate for a 30-year home loan fell to a low of 2.66% during this time.

During this time, savers weren’t earning as much interest on the money they had in the bank. When banks earn less interest on the loans they make to consumers, they tend to pay out lower annual percentage yields (APYs) to customers in response.

When the Federal Reserve raises the federal funds rate, as occurred more recently, banks and lenders typically respond by raising interest rates as well. You’ll feel the impact if you need to borrow money because when interest rates are higher, accessing credit can become more challenging and more expensive.

But a rate hike from the Fed could benefit savers. Higher interest rates from the Federal Reserve often influence banks and credit unions to offer higher APYs on a variety of deposit accounts.

As interest rates climb, many banks and credit unions may offer higher APYs on different types of savings products such as the following.

• Certificates of Deposit (CD)
• High-Yield Savings Accounts
• Savings Accounts
• Money Market Accounts

If you’re in a position to take advantage of the higher interest rates that financial institutions are offering when interest rates are high, you could benefit from the Federal Reserve’s efforts to curb inflation. But if you’re carrying large amounts of credit card debt, higher interest rates make it even more important to pay down your balances as soon as possible.

“The actions the Federal Reserve takes have the ability to impact your financial life (albeit in indirect ways) for the good or the bad. If you’re struggling with credit card debt, certain decisions the Fed makes are more likely to have a negative effect on your monthly budget. But if you can avoid high-interest debt and take advantage of rising APYs on deposit accounts when banks offer them, you might be able to benefit from the Fed’s decisions instead.”

— Michelle Lambright Black