Intro To The Federal Reserve System

The Federal Reserve, commonly dubbed as the “Fed,” is the gatekeeper of the U.S. economy. Its role is to regulate the nation’s financial institutions, such as banks, credit unions, etc. It’s always important to keep an eye on markets when it comes to the Fed meetings. The current chair is Jerome Powell. But before you listen to what he says, you must understand the roots of the Fed itself.

Photo by Alex Bierwagen on Unsplash

Origins of the Federal Reserve: The Panic of 1907

Heinze’s Plan

This plan failed spectacularly. Heinze did indeed bid up the price of his company’s shares, but when he called for short sellers to cover, the short sellers easily found other sources from which to buy United Copper Company’s shares cheaper than what Heinze was offering. After the massive buying, Heinze did not anticipate short-sellers finding another market for the stock. Because they found a market to buy the stock cheaper, the stock’s price collapsed. That ruined Heinze and the banks which he raised money from to finance his cornering effort.

Weakening Depositor Confidence and Bank Runs

Trust Companies

Liquidity Crisis

Due, in large part, to the efforts of financiers like J.P. Morgan and John D. Rockefeller, as well as the government, the panic was alleviated. The aftermath of this panic raised many questions about how to deal with the financial crisis and times where liquidity and funding were in short supply. These questions were answered with the creation of the Federal Reserve, the US’s central banking system.

Photo by Wikimedia Commons on The Nation: The Panic of 1907 on October 22, 1907

Regional Banks

FOMC

This committee holds four main responsibilities for the decisions of monetary policies:

  • Moderating all bank institutions to ensure customers are protected with their money
  • Providing certain financial services to the U.S. government, U.S. financial institutions, and foreign official institutions, and playing a major role in operating and overseeing the nation’s payments systems
  • Managing monetary policy, meaning changing the federal funds rate, which influences monetary and credit conditions across the nation
  • Maintaining the stability of the financial system by containing problems that may arise in financial markets
Photo by Federal Reserve

Federal Funds Rate

If a bank doesn’t have sufficient funds to pay withdrawals and interest for customers, the bank would have to borrow the funds to do so from another bank. Banks with more than the required minimum fund amount in their reserves can loan their funds in excess of that minimum to banks that don’t meet that requirement. The reserve requirement is a percentage of a bank’s total deposits, and it’s currently 10% for large banks. The reserve requirement ensures that banks have sufficient funds to cover withdrawals in case of an event that triggers mass withdrawals.

The Federal Reserve influences the federal funds rate by setting a target rate for it. When you hear that the Fed increased or decreased interest rates, it’s the target rate for the federal funds rate that changed. Those changes have a ripple effect on the interest rates and yields across all asset markets, especially the bond market.

A Guide to Interest Rate Hikes and Cuts

  • When the Fed cuts interest rates, banks loan money to each other at a lower, cheaper rate. That leads banks to issue cheaper loans, which leads to people taking out more loans. That results in those loans, of which there are more of, being used for a greater amount of spending. That spending leads to more business growth. That ultimately affects expectations of business growth and often leads to a more optimistic view that often contributes to rising stock and bond prices.
  • When the Fed hikes interest rates, banks loan money to each other at a higher, more expensive rate. That leads banks to issue more expensive loans, which leads to people taking out fewer loans. That results in those loans, of which there are fewer of, being used for a smaller amount of spending. That spending leads to less business growth. That ultimately affects expectations of business growth and often leads to a more pessimistic view that often contributes to declining stock and bond prices.

Key Takeaways

  • The FRS gives the nation a protected, adaptable, and stable monetary and financial system.
  • Referred to just as the Fed, it is involved 12 regional Federal Reserve Banks that are each liable for a particular geographic territory of the U.S.
  • The Fed's primary obligations incorporate directing monetary policy, administering and controlling banks, keeping up financial sustainability, and providing bank services.

By playing out the entirety of its different obligations — setting interest rates, supervising and regulating financial institutions, providing national payment services, and maintaining the stability of the nation’s financial system — the Fed is essential to watch out for as it assumes a pivotal job in saving the wellbeing of the economy, particularly during times of financial emergency.

student w/ a passion for finance and other things

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