Federal Reserve System

The creation of the US Federal Reserve System was enacted by the Federal Reserve Act on 23 December 1913, as a response to the severe crisis of 1907, "to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes" (Board of Governors of the Federal Reserve System, 2014, Official title). It was the third attempt to create a federal central banking system, after the First Bank of the United States (1791-1811) and the Second Bank of the United States (1816-36) failed.

The US Federal Reserve's duties fall into four general areas: conducting the nation's monetary policy, supervising and regulating banking institutions, maintaining the sta- bility of the financial system and containing systemic risk that may arise in financial markets, and providing financial services to depository institutions, the US government, and foreign official institutions (Board of Governors of the Federal Reserve System, 2005, p. 1).

The federal structure of the US Federal Reserve System aims at reflecting the economic diversity of the US territory: the System is composed of a central, federal government agency based in Washington, DC; the Board of Governors; and twelve regional Federal Reserve Banks, with twenty-five branches, whose functions include operating a nation- wide payments system, distributing the nation's currency and coins, supervising and regulating member banks and bank holding companies, and serving as banker for the US Treasury (ibid., p. 6).

The Board of Governors of the Federal Reserve System has authority over the Federal Reserve Banks and their branches. The seven members of the Board are appointed by the President of the United States and confirmed by the US Senate. However, the Federal Reserve is free from direct influence on monetary policy by the executive branch, and therefore qualifies as an independent central bank.

The 1951 Treasury-Federal Reserve Accord was paramount in establishing the Federal Reserve as independent, through "a lasting separation between monetary policy and the Treasury's debt management powers" (Moe, 2013, p. 3). However, it is subject to oversight by Congress and as such "[t]he independence of the Federal Reserve System does not mean independence from the Government but independence within the Government" (Joint Committee on the Economic Report, 1952, quoted in Moe, 2013, p. 65). The Accord did not entail entire insulation of monetary policy from the Federal government, since it was held that "fiscal and monetary policy must be coordinated with each other and with the other policies and objectives of the Government" (Report of the Subcommittee on General Credit Control and Debt Management, 1952, quoted in Moe, 2013, p. 65). The necessity for such coordina- tion has been revived in the aftermath of the 2008-09 global financial crisis (Federal Reserve and Treasury Department, 2009). Criticism has been levelled against the US Federal Reserve governance as insufficient to guarantee democratic accountability and, therefore, in need of structural reform so as to better serve public interest (see for example Schlesinger, 2009).

The Federal Reserve Act in its initial form did not contain macroeconomic policy objectives assigned to the Federal Reserve System. In accordance with the amendments brought in by the Federal Reserve Reform Act (1977) and the Full Employment and Balanced Growth Act (1978), its duty is "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates" (Board of Governors of the Federal Reserve System, 2014, section 2A). The Federal Reserve Board currently considers that price stability is achieved at 2 per cent inflation, and has set this rate as its target (Bernanke, 2013b, pp. 18-19).

The policy instrument used by the Federal Reserve is the federal funds rate; that is, the rate of interest at which depository institutions trade balances at the Federal Reserve. Control of the federal funds rate is exercised through four instruments: reserve requirements, contractual clearing balances, discount window lending, and open-market operations (Board of Governors of the Federal Reserve System, 2005, p. 3), the latter being the most significant instrument. Oversight of these operations is set under the responsibility of the Federal Open Market Committee, composed of the seven members of the Board of Governors of the Federal Reserve System and five of the twelve Reserve Bank presidents. The president of the Federal Reserve Bank of New York serves as a permanent member, while the other presidents serve one-year terms on a rotating basis (ibid., pp. 11-12).

The US Federal Reserve contributed to avoiding a major collapse of the US economy during the 2008 financial crisis by acting as a lender of last resort: it provided liquidity through the discount window and created special liquidity and credit facility programmes (Bernanke, 2013a, p. 77). In December 2008, with conventional monetary policy reaching its limits, the US Federal Reserve resorted to large-scale asset purchases, also known as "quantitative easing": the first round was announced in March 2009, the second one in November 2010, and the third one in September 2012.

On the regulatory front, the US Federal Reserve is in charge of writing and interpret- ing consumer protection regulations (Board of Governors of the Federal Reserve System, 2005, ch. 6). It is also in charge of supervising and regulating bank holding companies, state-chartered banks that are members of the Federal Reserve System (state member banks), foreign branches of member banks, Edge and agreement corporations, through which US banking organizations may conduct international banking activities, US state- licensed branches, agencies and representative offices of foreign banks, and non-banking activities of foreign banks (ibid., p. 61). In the aftermath of the financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) enhanced the US Federal Reserve's regulatory powers, and implementing key Dodd-Frank Act regulatory provisions is now part of its major priorities (Tarullo, 2013).

See also:

Banking supervision; Central bank independence; Federal Open Market Committee; First and Second Banks of the United States; Inflation targeting; Lender of last resort; Open-market operations; Quantitative easing; Reserve requirements.