Series: General Concepts

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What's the Fed, Anyway? Terms of Use:

Sometimes we hear people talk about how the "Feds" are going to raise interest rates, or the "Feds" are going to squeeze the money supply. When people talk about the Feds, they mean the Federal Reserve System.

The Federal Reserve System was created by something called the Federal Reserve Act of 1913. The Federal Reserve is the central bank of the United States and has many functions such as setting monetary policy and regulating banks.

Between 1781 and 1923, Congress tried three times to create a centralized bank like the ones in Europe. The first two failed because of fraud, and the third one fell apart because of politics. But something had to be done after a period of "bank panics" between 1880 and 1920.

If you've ever seen the movie, "It's a Wonderful Life", you'll know what a bank panic or "run" looks like. A run is caused when numerous bank customers try to withdraw their bank deposits at the same time and the bank's reserves are not sufficient to cover the withdrawals.

In the late 1800s and early 1900s, banks were often owned by speculators or people who gamble in risky financial markets.

Sometimes a rumor would start that a certain speculator was about to go bankrupt, and so the people who had money in his bank would panic, run to his bank and pull out their money. That would start a run on other banks, especially if some of them ran out of money. Banks often failed during these panics and then no one could get any of the money owed them.

The Great Panic of 1907 started with a rumor that the president of the Knickerbocker Trust was about to go bankrupt. On October 22, 1907, hundreds of people went to the Knickerbocker and pulled out $8 million within three hours. The trust closed forever at noon that day and many people lost all their savings.

Series: General Concepts

Page 2 of 2

What's the Fed, Anyway? Terms of Use:

The Fed was created to stop these kinds of bank panics by regulating banks and the supply of money in the United States. But even so, the worst bank panic in American history happened in 1929, well after the Fed was in place, and this led to the Great Depression of the 1930s. In that decade many more bank reforms got passed, including the creation of the FDIC and giving much more power to the Fed.

The Fed is a very unusual government agency in that it is allowed to work independently of our government. In many ways, it functions like a separate business corporation. It has three parts: twelve Federal Reserve Banks, the Federal Reserve Board of Governors, and the Federal Open Market Committee (FOMC).

Each of these three branches of the Fed has its own work to do. The twelve Federal Reserve Banks actually work as banks for

other banks and the United States government, and they enforce banking laws in their districts.

The Federal Reserve Board of Governors is in Washington D.C. and supervises the entire system. The President of the United States appoints the Board’s seven members, who are confirmed by the Senate to serve 14 years.

The President also appoints the board chairman and vice chairman to serve 4 years. The Board oversees the twelve Federal Reserve banks, and takes part on the Federal Open Market Committee. The Federal Open Market Committee meets every five or six weeks and makes major decisions that influence the American economy.

Click here for Fed 101 - in depth information on the Federal Reserve.

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