Source: Image of Federal Reserve Districts, creative commons, http://en.wikipedia.org/wiki/File:Federal_Reserve_Districts_Map_-_Banks_%26_Branches.png, Image of one dollar bill, public domain, http://en.wikipedia.org/wiki/File:Onedolar2009series.jpg
Hi, welcome to Macroeconomics. This is Kate. This tutorial is on the US central bank, which is the Federal Reserve. As always, my key terms are in red and my examples are in green.
So in this tutorial, we'll talk about when and why the Fed was created. And we'll look at what the Fed is and how it's structured. You'll see there's a Board of Governors and Chairman of the Fed. I'll also show you the 12 Federal Reserve Districts in our country and talk about the Federal Open Market Committee, or FOMC. We'll also detail some of the primary responsibilities of the Fed.
So even though there was a central banking system developed already as of the early 1900s, that really had been put in place to standardize US currency. And that was certainly helping matters. But there were still issues.
In 1907 there was a huge panic. And a panic is where people run to the banks in large quantities to demand all of their money. And when that's the case, banks don't have enough to meet those demands. These panics are really terrible for our macroeconomy because it reduces the confidence of people. And it just can be very difficult to get back on track.
So partly to try to prevent future panics from happening, in 1913 President Woodrow Wilson signed the Federal Reserve Act into law. And that created the Fed as we know it today.
So this act authorized the Fed to be the only monetary authority in our country. It's important to understand that, unlike a lot of central banks, our Fed is not directly controlled by our federal government. So the Federal Reserve is defined as the central banking authority for the United States with direct oversight authority for monetary policy.
So how is the Fed structured? Well, it's headed by a Board of Governors. And these are seven people, seven members who are appointed by the President and confirmed by the Senate. So although not directly controlled by the government, there is an appointment by the President and confirmation by the Senate required. But they're not elected as some of our government officials are.
They have 14 years staggered terms. I know my students are sometimes surprised by the length of that. But as you learn about monetary policy, you'll see that consistency and stability is pretty important. That if things are overhauled or changed to rapidly, that can be pretty dangerous for our monetary policy and for our system. So for that reason, they do serve 14-year staggered terms.
Our Chairman of the Fed is a very important person. And he or she is appointed by the President as well and confirmed by the Senate. This person has a shorter terms at four years. But they are renewable. Some of our Fed chairmen in the past have served multiple terms, a long time. And others have not served as long. So it depends.
The Federal Reserve Board of Governors then is defined as the seven-member governing board of the Federal Reserve. The members are nominated by the president and confirmed by the Senate to serve this 14-year staggered term.
So we have 12 Federal Reserve Districts in our country. You can see that on this map here that I'm showing you, all of the different Districts. Some of them are much bigger, you can see, in size than others. But a lot of it's population-based. A lot of it's also what similar banking conditions might be.
You can see maybe what reserve District you're located in. I live in Pittsburgh, Pennsylvania, so mine is actually District Four. They split up the state of Pennsylvania. And I'm in Four instead of Three where Philadelphia is.
The point of these is to report about economic and banking conditions in each region. So what's going on in my District here in District Four might be very different from banking conditions out in District Twelve. And each District then is responsible for controlling the money supply for each region.
Every bill that we have actually indicates which District it originated from. You can see this letter inside of here is a code for what District it came from. This one is from New York.
So banks can choose to either hold their reserves as vault cash-- so they can actually hold it at their actual bank. We talked about reserves as what's required for them to keep on hand. And some of them choose to keep it at their actual bank. But a lot of them actually choose to keep their reserves at the regional Federal Reserve District Bank. So the Fed then makes these reserves available to banks if and when customers want to withdraw their money.
The Federal Reserve Districts act also as a lender of last resort. So this is going to prevent more of those runs and panics. Usually, if they haven't met their daily reserve requirement-- because they have to report daily about them-- if they haven't met them, if their reserves are running too low, they're going to borrow from another member bank. And when they do that they pay something called the fed funds rate.
But if they need to, they absolutely can borrow from the Federal Reserve. And here they would pay the discount rate to do so. It's important that our Fed is acting here as a lender of last resort. Because this means that there is confidence on the part of consumers knowing that, if their bank's running low, they're not going to run out of money. Their money will in fact be there.
Another purpose of the Federal Reserve Districts is to clear checks. So this is how banks record whose account is giving up money and whose account is receiving money. So here's an example for you. If I write a check and I'm banking with Bank A but I write a check to a friend who doesn't bank with my bank. Their banking with Bank B.
What the Fed does is they step in and first of all verify that the funds are available for my account. And then they do the transferring. They transfer actually reserves from Bank A to reserves in Bank B. Bank B, once they receive those reserves, then gives the money to my friend. And aha! The check cleared. So that's how it works. This is all electronic today by the way.
So finally, we have that FOMC, this Federal Open Market Committee. And one of the biggest things that the Fed is known for and what their most important role is to regulate our nations money supply. So the FOMC is going to make really key decisions about interest rates and the growth of the money supply in our country. They meet about eight times a year. And the members of the FOMC come from the Board of Governors, so those seven people. And then the District reserve, all those 12 different Districts, the District Reserve Bank presidents. They actually rotate in and out with those bank presidents sitting on the FOMC.
So the Federal Open Market Committee is defined for you here, mostly what we just talked about. It's a committee within the Federal Reserve System that has responsibility and oversight of open market operations. So that's the buying and selling of US Treasury securities. The reason they buy and sell US Treasury securities is for the purpose of interest rate and money supply management. We'll talk about that in a different tutorial. And this is one of the key components of monetary policy.
The committee is also going to set the target for that federal funds rate that were talking about when banks borrow from one another. So they'll set a target rate.
So in this tutorial we talked about when and why the Fed was created. We looked at what the Fed is and how it's structured. You saw the board of governors and the chairman of the fat and what they're all about. I showed you the 12 Federal Reserve Districts and we talked about some of the things that they're responsible for doing. And finally we ended by talking about the important Federal Open Market Committee, who is really responsible for managing our nation's money supply. And because we talked about all those things, we looked at the primary responsibilities of the Fed.
Thanks so much for listening. Have a great day.
Terms to Know
The central banking authority for the United States with direct oversight authority for monetary policy.
Federal Reserve Board of Governors
The seven member governing board of the Federal Reserve Board. The members are nominated by the President and confirmed by the Senate to serve a fourteen-year staggered term.
Federal Open Market Committee (FOMC)
A committee within the Federal Reserve System that has responsibility and oversight of open market operations, buying and selling of U.S. Treasury securities for the purpose of interest rate and money supply management, one of the key components of monetary policy. The committee also sets the target for the federal funds target rate.