The Federal Reserve is the most powerful financial institution in the world. One way or another, his actions and policies touch your daily life. Here are some things you should know about this powerful but misunderstood institution.
The Federal Reserve is the central bank of the United States of America. The main role of the central bank is to ensure that money and credit are available in the economy. It also regulates banks and oversees all financial transactions.
One of the most visible things the Fed does is issue banknotes. Take a look at a dollar bill. On the front of the bill you will see “Federal Reserve Note” printed above the image of George Washington. To George’s left you will see a stamp with the words “United States Federal Reserve System”. Under this stamp, you will find the reassuring mention: “This note is legal tender for all public and private debts”. The Federal Reserve is the only entity legally authorized to issue US currency, a monopoly vigorously enforced by the US Secret Service.
The Fed’s power to create money extends to the creation of money and credit in general, not just the money we carry in our pockets. Banks and other financial institutions are essential to this process as they provide loans and facilitate transactions in the economy. And while cryptocurrencies are trying to redefine that monopoly, for now, at least, the Federal Reserve is the ultimate source of credit flowing through the economy.
The Federal Reserve System was created in 1913 when President Woodrow Wilson signed into law the Federal Reserve Act. The law came in response to decades of economic boom and bust marked by bank runs and financial panics. Without a central bank, there was no “lender of last resort” capable of providing credit in times of crisis. In fact, in both 1893 and 1907, the economy nearly collapsed and only stabilized when financial magnate JP Morgan stepped in. In the years since its creation, the Federal Reserve has helped bring more stability and elasticity to the US financial system. It wasn’t perfect, but it was much better than before.
The Federal Reserve’s congressional charter requires that it “effectively promote the goals of maximum employment, stable prices, and moderate long-term interest rates.” Fulfilling this mandate is tricky because promoting price stability sometimes requires actions that result in higher interest rates, slower economic growth and reduced employment. While the Fed is nominally independent of the White House and Congress, the reality is that it faces tremendous political pressure as it tries to balance its dual mandate.
One of the Fed’s most important jobs is done by what’s called the Federal Open Market Committee, or FOMC. The FOMC meets in two-day meetings eight times a year to review the direction of monetary policy and the speed with which it is implemented. FOMC decisions have the power to move markets around the world. Billions of dollars are at stake as stock and bond traders try to parse the meaning of statements released by the FOMC.
The first FOMC meeting of 2022 took place on Tuesday and Wednesday. By any measure, this month’s reunion is full of drama. As the Fed grapples with runaway inflation and economic uncertainty caused by the latest wave of COVID, questions abound. Did the FOMC vote for a rate hike or will it let inflation last longer? Have they slowed their bond purchases more quickly or will they stay the course? Whatever their decision, each of us will be affected by their decision.
The FOMC usually issues a press release on the second day of its meeting. The release summarizes all of the decisions made by the FOMC and the factors considered in making them. Full minutes of each FOMC meeting are made public three weeks after the meeting ends.
Steven C. Merrell is a partner at Monterey Private Wealth Inc., an independent wealth management firm in Monterey. He welcomes your questions regarding investments, taxes, retirement or estate planning. Send questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to [email protected]