What is The Federal Reserve?
The Federal Reserve, Fed, is the central bank of the United States. The Fed reinforces the stability of the financial system, sets monetary policy and supervises banks nationwide. Other responsibilities include stabilizing financial markets, regulating the banking system and conducting financial services to the government. The Federal reserve system shapes the financial system by influencing all financial aspects of the economy.
The Federal Reserve works on promoting the health of the U.S. economy and the stability of the U.S. financial system. The central bank is a privileged authority to issue currency, function as the bank of the government, manage exchange reserves, regulate the credit system, oversee commercial banks and act as a lender of last resort.
The Fed is considered to be the most influential and powerful financial institution worldwide.
The Federal Reserve System Explained
The Fed was established over a century ago, after the congress passed the Federal Reserve Act of 1913 in the wake of the financial panic in 1907. Initially, the congress designed the Fed as an establishment of Federal Reserve banks and an effective supervision of the banking system in the United States. Over the years, the Fed’s authority expanded to supervise and control all financial aspects. At present, the Fed conducts monetary policy to maintain price stability and maximum employment using monetary tools. In addition to supervising the banking system.
The Fed performs five main functions to promote the effective operation of the U.S. economy and the public interest.
- The Fed conducts the monetary policy to achieve maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy.
- Promotes the stability of the financial system and act to minimize and contain systemic risks through active monitoring and engagement.
- Maintains the safety and soundness of individual financial institutions while monitoring their impact on the financial system.
- Enhances payment system efficiency and safety through services to the banking industry and the U.S. government that facilitate U.S.-dollar transactions and payments.
- Ensures consumer protection through consumer-focused supervision and examination, research and analysis of emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations.
The Structure of the Federal Reserve System
There are three main entities that form the Federal Reserve System; The Board of Governors, the Federal Reserve Banks, and the Federal Open Market Committee. All Entities work together to promote the health of the economy and the stability of the financial system.
Under the Federal Reserve System, the United States is divided geographically into twelve districts based on economic considerations. Each district operates independently but all falls under the supervision of the Federal Reserve Board of Governors.
The Federal Open Market Committee (FOMC)
The FOMC is the body of the Federal Reserve System that sets national monetary policy by directing open market operations (OMOs). The FOMC committee consists of twelve voting members. The committee decides the appropriate stance of monetary policy to achieve policy mandates of price stability and maximum employment. The FOMC committee moves the federal funds rate to achieve the policy mandates. The committee typically meets eight times each year, and at other times as needed.
2022 FOMC Meeting Calendar
Interest Rate and Policy Mandates
The central bank adopts an expansionary policy that includes lowering interest rates to make borrowing cheaper. This allows individuals and businesses to borrow and spend more. That usually happens in times of a slowing economy. With higher demand, employment increases, unemployment falls and prices rise. That’s when the policy shifts to a contractionary phase by raising interest rates.
Rising interest rates are commonly known as hitting the brakes of the economy. It helps slow down the economy and keeps it from overheating. Higher rates make borrowing and spending cost more, so businesses and consumers borrow less and slow down the economy.
In response to the COVID-19 pandemic, the Fed lowered interest rates twice to its current near zero levels to ease the impact on employment and the economy.
How to Trade Fed’s Decisions?
The Fed is known for being data dependent. It means that the policy path is adjustable based on economic activity, achieving policy mandates and financial conditions. Short-term forecasts tend to be more valuable for investors, as longer-term views are more vulnerable to change.
The Fed is an independent institution with broad authority over monetary and financial conditions. Its independence is critical and ensures setting the proper policies and decisions to achieve long-term economic goals, depending solely on economic situation and indicators.
Changes in interest rates directly impact the US Dollar. Typically, intending to hike interest rates or maintain neutral levels is good for the currency. In contrast to when the central bank intends to cut interest rates or maintain high levels. Investors are attracted to higher yields. When the interest rate rises, foreign investors tend to switch from their local currency investments to USD denominated investments which supports the value of the US dollar.
Can I forecast the Fed’s decisions? Yes, the Fed keeps highly transparent communication with the publisher regarding its policy path. The dot plot is one of the most influential communication tools used by the FOMC. Know more about how to interpret the dot plot and forecast changes in interest rates.
Monetary policy decisions not only affect the economy but the financial markets as well. The policies of the Fed also influence monetary policies for many other countries.
Trade Fed Decisions
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