Federal reserve bank Chicago

The Fed: What is it, and what does it do?

As the nation’s central bank, the Fed promotes the stability of financial institutions and enacts policies that impact employment and prices.

The Federal Reserve, or Fed, was created in 1913 to reduce the impact of financial crises that had plagued the U.S. for several years. As the nation's central bank, the Fed promotes the stability of financial institutions and enacts policies that impact employment and prices of consumer goods.

So, what exactly is the Fed, and how does it Influence the economy and the housing sector?  

 What is the Fed? 

The Federal Reserve, or Fed, is the central bank of the United States and an independent agency of the U.S. government. It is often referred to as "the banker's bank" for its part in facilitating payments across the financial system and as "the government's bank" for its role in processing trillions of dollars in federal government receipts and payments.  While it generally operates out of the public eye, it makes the news when it adjusts policies that affect interest rates on loans, mortgages and credit cards.  

What does the Fed do? 

The Fed has five key functions:  

  • Conduct the nation's monetary policy to promote maximum employment and stable prices 

  • Promote the stability of the financial system 

  • Promote the safety and soundness of individual financial institutions 

  • Oversee payment and settlement system safety 

  • Promote consumer protection and community development 

To carry out these responsibilities, the Fed Is organized into three separate entities: 

  • Board of Governors: A seven-member board that guides the operations of the Federal Reserve System. Members are nominated by the president, confirmed by the senate and appointed to a 14-year, staggered term. Jerome Powell, who joined the Board in 2012, was elevated to Chair in 2018.  

  • Federal Reserve Banks: These 12 banks supervise banking in their region. They provide financial services and enforce policy and regulatory compliance.  

  • Federal Open Market Committee (FOMC): A 12-member committee that sets monetary policy using a range of tools to achieve the mandated goals of maximum employment and stable prices.  

Where does the Fed get the resources to operate such a large, complex system? 

The Fed Is not funded by congressional appropriations. Operations are primarily financed by interest earned on securities acquired through its monetary policy activities. After covering expenses and allocations to a capital surplus, all net earnings are transferred to the U.S. Treasury. In 2021, the Fed transferred $107.4 billion to the Treasury, an increase from $86.9 billion In 2020. Although the Fed is self-funded, it is still accountable to congress. In addition to providing reports to congress, the Chair and staff are frequently called on to testify about Fed policy and the economy.  

Does congress or the president tell the Fed what to do? 

As much as members of congress or the president may want to tell the Fed what to do, the Fed jealously maintains its independence when determining and implementing its policy actions. Central bank independence is a characteristic of many central banks across the globe and is designed to keep political influence and meddling to a minimum.  

That means the Fed sometimes takes actions elected officials won't like, such as raising the federal funds rate during an election year. As former Chair William McChesney Martin famously said, the job of the Fed is "to take away the punch bowl just as the party gets going." 

The Fed conducts monetary policy, but what does that mean? 

The Fed, or more specifically, the FOMC, sets the federal funds rate — the rate that U.S. financial institutions charge each other for overnight loans of reserves deposited at the Fed. The Fed does not set or control medium- or long-term rates such as mortgage or credit card rates, but its actions influence those rates. When the federal funds rate changes, other interest rates adjust based in part on whether financial markets expect the Fed to continue raising or lowering the federal funds rate. If the Fed is expected to raise the federal funds rate in the future, then rates on mortgages and other loans will generally rise.  

How does the Fed conduct monetary policy? 

The FOMC meets eight times per year to assess the state of the economy and determine if the current federal funds rate is consistent with the dual objectives of maximum employment and stable prices. If the economy is running too hot and inflation is at a sustained level above the Fed's 2% target rate, then the FOMC will likely raise the federal funds rate to slow the economy and reduce pressure on prices. Alternatively, if the economy is weak or headed for a recession, the FOMC will usually lower the federal funds rate with the expectation that interest rates on loans and credit cards will also decline and give the economy a boost.  

Immediately following each FOMC meeting, the Fed Chair holds a press conference to inform the public about any policy actions and the rationale behind them. This provides a window into the thinking of FOMC members about the state of the economy that may hint at future actions. Financial markets pay close attention to comments by the Chair which, apart from any direct actions by the FOMC, also influence medium- and long-term interest rates. 

What impact does the Fed have on the economy and housing market?  

By changing the federal funds rate, and indirectly other interest rates, the Fed exerts a considerable amount of influence on the economy. Higher interest rates, for example, will cause borrowing costs to rise for both consumers and businesses. Depending on how much interest rates rise, firms may slow the pace of hiring or lay off workers. Consumers, deterred by rising interest rates, may cut back on spending and delay or forego big-ticket purchases such as cars and homes.  

The housing market is affected directly through changes in mortgage rates stemming from the Fed's influence on financial markets, and indirectly through the impact of Fed actions on jobs and income, both of which are closely linked to consumers' desire and ability to buy homes.  

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