What is the role of the Federal Reserve?  You can’t turn on the television without being bombarded with the latest and greatest reason to be scared.  The reason today, it seems, is the minute to minute decisions or potential decisions of the Federal Reserve.  But, few people really understand what the Federal Reserve system is, why the exist, and the actual role of the Fed.  But, we sure do react with great fury at this body’s pronouncements.  

What is the Federal Reserve?

The Federal Reserve is the federal banking authority in the US that performs the functions of a central bank.  This Federal Reserve implements the country’s monetary policy, providing a national system of reserve cash available to banks. They have been given the power to lend to each other at an overnight rate to ensure liquidity for its member banks.  This system was created in 1913 and its role in shaping our economy has grown over the past 109 years to become the economic behemoth that it is today.  The Fed has enormous influence on interest rates, money supply, and many other aspects of our day to day economic lives.

It has become, “a hydra-headed monster… it impaired the morals of our people, corrupted our statesmen, and threatened our liberty. It bought up members of Congress by the Dozen… and sought to destroy our republican institutions.” – Andrew Jackson

Why was the Federal Reserve Created?

In 1913, President Woodrow Wilson signed the Federal Reserve Act.  This created 12 public-private regional banks that were tasked to provide stability to the banking system.  In essence, they were to be the lender of last resort.  Prior to this creation, there were runs on banks that were severe enough to close banks and provide fear in the system.  What Panics led to this need?

• 1893 – Banking Panic Causes the Worst Depression the United States had ever seen.
  
• 1907 – Wall Street Speculation Causes another Banking Panic
  

In both the Banking Panic of 1893 and the 1907 crash, it was JP Morgan that came to the rescue.  It was clear that a stronger central bank would work to alleviate this pressure from the financial system.

What Functions do the Federal Reserve Banks Serve?

 

The Federal Reserve Act of 1913 did a great job with respect to its original intent.  The Banking system had an emergency backstop.  And, when a future run would happen on a bank, there was cash on the way from the system.  No longer would banks be  put down by a “run”.  The role of the Federal Reserve system has transformed over the years, and more power has been given to this system than was orginally intended.

The Federal Reserve now has five main functions:

• Conducting monetary policy
  
• Promoting financial system stability
  
• Supervising and regulating financial institutions and activities
  
• Promoting consumer protection
  
• Fostering payment and settlement system safety and efficiency
  

 

Why is the Federal Reserve Important?

 

For investors, the ongoing transactions of the Federal Reserve is important for the daily gyrations and volatility of the Stock Market.  Through monetary policy, they have a major impact on inflation.  By backstopping the banking sector, it provides stability and security.

Unfortunately, this semblance of security comes at a cost.  By providing stability, it also creates bubbles.  And bubbles ultimately burst.

Listen to the radio show below to hear some of the best investment minds as they debate current Fed Policy and future Fed Action.  They also expand on the role of the Federal Reserve as well as many other topics that affect you and your money.

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