Federal Reserve
Based on Wikipedia: Federal Reserve
In the autumn of 1907, a failed attempt to corner the copper market triggered a cascade of bank failures that nearly brought the American financial system to its knees. There was no central bank to step in. No lender of last resort. The person who ultimately saved the economy was a seventy-year-old private citizen named J.P. Morgan, who locked the nation's leading bankers in his library and refused to let them leave until they agreed to pool their resources and stop the panic.
That one man—however capable—could wield such power over an entire nation's finances struck many Americans as deeply troubling. Six years later, Congress created the Federal Reserve System, an institution designed to ensure that the fate of the American economy would never again rest in the hands of a single banker.
Today, the Federal Reserve—usually just called "the Fed"—is the central banking system of the United States, arguably the most powerful economic institution in the world. Its decisions ripple through global markets within seconds. When the Fed speaks, stock prices move, mortgage rates shift, and finance ministers on every continent pay attention.
Yet for all its influence, the Fed remains poorly understood by most Americans. What exactly does it do? Who controls it? And why does a democratic nation have an institution that explicitly operates independent of elected officials?
What a Central Bank Actually Does
To understand the Fed, you first need to understand what a central bank is and why countries have them.
Imagine an economy without one. Banks take deposits from customers and lend most of that money out to borrowers—this is called fractional-reserve banking. The bank keeps only a fraction of deposits on hand, confident that not everyone will want their money back at the same time.
This works beautifully until it doesn't.
If rumors spread that a bank might be in trouble, depositors rush to withdraw their savings before the money runs out. But the money isn't there—it's been lent out to homeowners and businesses. The bank fails. Panic spreads to other banks. Credit freezes. Businesses can't make payroll. The economy seizes up.
This is a bank run, and before the Fed existed, they happened with disturbing regularity. The United States experienced major financial panics in 1873, 1884, 1893, and 1907.
A central bank solves this problem by serving as a "lender of last resort." When a bank faces a run, it can borrow from the central bank to meet withdrawal demands, breaking the cycle of panic. The mere existence of this backstop often prevents runs from starting in the first place—if depositors know their bank can always get cash from the central bank, why rush to withdraw?
The Fed's Three Jobs
Congress gave the Federal Reserve three primary objectives, often called its "dual mandate" (the third goal tends to follow naturally from the first two):
Maximum employment. The Fed tries to keep as many Americans working as possible, though it recognizes that some unemployment is natural and even healthy—people between jobs, recent graduates searching for their first position, and so on.
Stable prices. The Fed aims for inflation of about two percent per year. Not zero—a little inflation gives the economy room to adjust and discourages people from hoarding cash. But not too much either. High inflation erodes savings, makes planning impossible, and tends to hurt the poor most severely.
Moderate long-term interest rates. This one is less discussed, but it matters. When interest rates are stable and predictable, businesses can plan investments and families can budget for mortgages.
These goals sometimes conflict. Pushing for maximum employment can fuel inflation. Fighting inflation may require policies that increase unemployment. The Fed constantly balances these tensions, and reasonable people disagree about whether it strikes the right balance.
How the Fed Controls the Economy
The Fed's primary tool is interest rates—specifically, a rate called the federal funds rate.
Here's how it works. Banks are required to keep reserves—cash or deposits at the Fed—equal to a certain fraction of their customer deposits. Banks with excess reserves can lend to banks that need more. The federal funds rate is the interest rate banks charge each other for these overnight loans.
Why does this matter? Because this rate influences every other interest rate in the economy. When the Fed raises the federal funds rate, borrowing becomes more expensive throughout the system. Credit card rates rise. Mortgages cost more. Business loans get pricier. People borrow less, spend less, and the economy cools down. Inflation slows.
When the Fed lowers rates, the opposite happens. Borrowing becomes cheaper. People buy houses, cars, and appliances. Businesses expand. The economy heats up. Employment rises.
The committee that makes these decisions is called the Federal Open Market Committee, or F.O.M.C. It meets eight times a year, and its announcements are among the most closely watched events in global finance. Analysts parse every word of its statements, looking for hints about future policy.
A Deliberately Strange Structure
The Fed has an unusual design, born from an old American tension: distrust of concentrated power, whether in government or in private hands.
Farmers and populists in 1913 wanted a central bank controlled by the public, not by wealthy bankers. Bankers wanted an institution free from political meddling. The result was a compromise that satisfied no one completely but has proven remarkably durable.
At the top sits the Board of Governors, seven members appointed by the President and confirmed by the Senate. They serve staggered fourteen-year terms—longer than any President's tenure—precisely to insulate them from political pressure. The Chair of the Fed, currently the most visible figure, serves a four-year term but can be reappointed.
Below the Board are twelve regional Federal Reserve Banks, scattered across the country in cities like Boston, New York, Chicago, Dallas, and San Francisco. These aren't typical government agencies. They're structured more like private corporations, with stock owned by member banks in their district. Commercial banks elect some of the directors of their regional Fed bank.
This hybrid structure—part public, part private—confuses people. The Fed isn't funded by Congress. It makes money by holding government bonds and other assets, earning interest that far exceeds its operating costs. In 2015, the Fed earned over one hundred billion dollars and sent nearly ninety-eight billion of that to the U.S. Treasury.
Critics find this arrangement troubling. Supporters argue it protects monetary policy from short-term political pressures. Elected officials facing reelection might want the Fed to juice the economy right before an election, even if that causes problems later. Independence, the argument goes, allows the Fed to make unpopular decisions when necessary.
The Government's Bank
Beyond monetary policy, the Fed performs more mundane but essential functions. It's the banker for the federal government itself.
The Treasury Department keeps a checking account at the Fed. When you pay your taxes, the money flows through the Fed. When the government sends you a Social Security check or a tax refund, that comes through the Fed too. The institution processes financial transactions involving trillions of dollars.
The Fed also distributes the nation's currency. This creates an interesting quirk in how money gets made. The Treasury Department—specifically the Bureau of Engraving and Printing—actually prints paper currency. It then sells this currency to the Fed at manufacturing cost, which works out to a few cents per bill. The Fed distributes the bills to commercial banks as needed.
In fiscal year 2020, the Bureau of Engraving and Printing delivered nearly fifty-eight billion notes to the Federal Reserve at an average cost of 7.4 cents each.
Supervision and Regulation
The Fed also regulates banks, though it shares this responsibility with other agencies in a characteristically American patchwork of overlapping jurisdictions.
The Fed directly supervises state-chartered banks that choose to join the Federal Reserve System, bank holding companies, and the American activities of foreign banks. Other regulators handle other pieces: the Office of the Comptroller of the Currency oversees nationally chartered banks, while the Federal Deposit Insurance Corporation—the F.D.I.C., the agency that guarantees your bank deposits up to a certain limit—supervises state banks that aren't Fed members.
Beyond bank safety, the Fed enforces consumer protection laws covering credit. If you've ever received a disclosure form explaining your credit card's interest rate or your rights when applying for a mortgage, those requirements trace back to regulations the Fed administers.
When Things Go Wrong
The Fed's most dramatic moments come during crises. On September 16, 2008, as the financial system teetered on the edge of collapse, the Federal Reserve Board authorized an eighty-five billion dollar emergency loan to American International Group, the giant insurance company. A.I.G. had made disastrous bets on mortgage-backed securities, and its failure threatened to pull down dozens of other financial institutions.
This kind of emergency lending is exactly what a central bank is supposed to do—step in when private markets freeze, provide liquidity to prevent contagion, and keep a manageable problem from becoming a catastrophe.
But such interventions attract fierce criticism. Bailing out a company like A.I.G. raises uncomfortable questions. If the Fed rescues firms that make reckless bets, doesn't that encourage more recklessness? Economists call this "moral hazard"—the tendency for people to take bigger risks when they know someone else will bear the consequences.
The Nobel Prize-winning economist Milton Friedman was one of the Fed's most famous critics. He argued that the Fed's failures during the Great Depression—specifically its refusal to lend to struggling small banks during the bank runs of 1929—transformed a recession into a catastrophe. In Friedman's view, the Fed didn't cause the initial downturn, but it made everything dramatically worse through tight monetary policy when it should have been flooding the system with liquidity.
The Critics
The Fed has always had detractors, from both left and right.
Some critics argue the Fed is too cozy with the banks it regulates, that its structure gives private financial interests too much influence over public policy. The fact that commercial banks own stock in regional Fed banks and elect some of their directors strikes these critics as a fundamental conflict of interest.
Others, like former Congressman Ron Paul, argue the Fed itself is the problem. They point to the abandonment of the gold standard—the system under which dollars could be exchanged for a fixed amount of gold—as the original sin. Under a gold standard, the Fed couldn't simply create money at will. When the United States fully abandoned gold in 1971, critics argue, it opened the door to chronic inflation and financial instability.
There's also a transparency critique. The Fed operates with significant secrecy about its operations, particularly around emergency lending. While the Government Accountability Office can audit many Fed functions, significant restrictions limit what investigators can examine. Critics argue the American public has a right to know what their central bank is doing with their money.
Defenders counter that some secrecy is essential. If the Fed had to announce in real time which banks were borrowing from its emergency facilities, that information alone could trigger the very bank runs the lending is meant to prevent.
The Check That Didn't Clear
One of the Fed's less glamorous but genuinely useful functions is operating the nation's check-clearing system.
Before the Fed existed, banks sometimes refused to honor checks drawn on other banks, particularly during financial panics. If Bank A didn't trust Bank B, it might refuse to accept checks from Bank B's customers. This made commerce difficult and could accelerate financial crises.
The Fed created a national system for clearing checks, serving as a trusted intermediary. When you write a check, it doesn't actually move physical dollars from your bank to the recipient's bank. Instead, the Fed adjusts the reserve accounts of both banks, crediting one and debiting the other. The Fed can even physically transport paper checks when necessary, though electronic processing has made this increasingly rare.
The Discount Window
Beyond emergency bailouts, the Fed provides routine lending to banks through what's called the "discount window." The name dates from an era when banks would bring commercial paper—short-term loans they'd made to businesses—to the Fed to be "discounted," or converted to cash at less than face value.
Today, banks that need short-term cash can borrow from the Fed, paying an interest rate called the "discount rate." This serves as a safety valve. If a bank experiences unexpected withdrawals—a large depositor pulls funds, seasonal factors reduce deposits, whatever—it can borrow from the Fed to meet its obligations without having to call in loans or sell assets at fire-sale prices.
The discount rate is typically set above the federal funds rate, so banks prefer to borrow from each other. But knowing the Fed stands ready to lend provides a reassuring backstop, smoothing out the day-to-day fluctuations in the banking system.
Research and Publications
The Fed doesn't just regulate and lend—it also studies the economy with an intensity few other institutions can match. Each regional Fed bank has a research department staffed with economists who analyze everything from local labor markets to global financial flows.
The most famous Fed publication is the Beige Book, released eight times a year before each F.O.M.C. meeting. It summarizes economic conditions across the twelve Fed districts, based on reports from business contacts, economists, and other sources. The Beige Book's anecdotes and qualitative assessments often capture economic shifts before they show up in official statistics.
The Fed also maintains F.R.E.D., the Federal Reserve Economic Data database, which has become an indispensable resource for economists, journalists, and anyone else trying to understand the American economy. It contains hundreds of thousands of data series, from unemployment rates to money supply to housing starts, all freely available to the public.
Independence Under Pressure
The Fed's independence is not absolute and has never been uncontroversial.
Presidents have repeatedly pressured Fed chairs to pursue policies the White House favored. Richard Nixon leaned on Arthur Burns to keep money loose before the 1972 election. Lyndon Johnson reportedly shoved Fed chair William McChesney Martin against a wall during an argument about interest rates.
The Fed's defenders argue that presidential pressure is precisely why independence matters. A Fed chair who can't be fired at will can tell the President no. A central bank that answers to politicians might juice the economy before elections, generating short-term growth at the cost of long-term inflation.
Critics counter that unelected officials making decisions with enormous consequences for ordinary Americans raises democratic concerns. The Fed's independence means that monetary policy—which affects everything from the job market to housing prices to retirement savings—sits outside normal democratic accountability.
This tension has grown sharper in recent years, as the Fed's role has expanded. During the 2008 financial crisis and the 2020 pandemic, the Fed took unprecedented actions, lending trillions of dollars and purchasing assets it had never bought before. Each expansion of Fed power makes the accountability question more urgent.
The World's Central Bank
Although the Fed is technically just America's central bank, the dollar's role as the world's reserve currency gives Fed decisions global reach.
When the Fed raises interest rates, it attracts capital to the United States, strengthening the dollar. This can cause problems for countries that have borrowed in dollars—their debt becomes more expensive to service. Emerging market crises have repeatedly followed Fed tightening cycles.
The Fed chair meets regularly with central bankers from other countries and plays a formal role in international economic coordination. What happens in the Eccles Building—the Fed's headquarters in Washington—echoes in trading floors from Tokyo to London to São Paulo.
A Hundred Years of Evolution
The Fed of today barely resembles the institution Congress created in 1913. Each major crisis has expanded its role.
The Great Depression led to new powers and new responsibilities for bank supervision. The inflation of the 1970s prompted a sharper focus on price stability. The 2008 financial crisis saw the Fed become deeply involved in regulating systemic risk and "macroprudential" policy—trying to prevent the buildup of risks that could threaten the entire financial system.
Whether these expansions represent appropriate adaptations to new challenges or dangerous mission creep depends on your perspective. What seems clear is that the Fed will continue evolving. The institution that emerges from the next crisis will likely be different from the one that entered it.
That's the nature of central banking. It's always a work in progress, always contested, always consequential. The arguments that played out in J.P. Morgan's library in 1907, in the halls of Congress in 1913, in the smoky backrooms of the Nixon administration—they continue today, in different forms but with the same underlying tensions.
How much power should one institution have over the economy? How do you balance independence with accountability? How do you prepare for crises you can't foresee? These questions don't have final answers. The Federal Reserve is America's ongoing attempt to work them out.