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How Does the Federal Reserve work?

By Mike Unger

Eric Pajonk

Eric Pajonk

An interview with Eric Pajonk, media relations director of the Federal Reserve Bank of New York. 

The Federal Reserve is the central bank of the United States. It’s composed of a central, independent governmental agency called the Board of Governors in Washington, DC, and a dozen regional Federal Reserve Banks in cities throughout the nation.

President Woodrow Wilson established it in 1913 when he signed the Federal Reserve Act into law. Prior to that, the US economy was plagued by frequent episodes of financial turmoil, bank failures, and credit scarcity, most notably the Panic of 1907. In response, the Fed, as it’s come to be known, was created to provide the nation with a safer, more flexible, and more stable monetary and financial system.

The entire Federal Reserve System has about 20,000 employees. They are a wide range of professionals, from economists, markets experts, and bank examiners to staff that handle cash processing and even gold vault custodians. Janet Yellen is the chair of the Federal Reserve Board.

The Fed has four general responsibilities. First, we conduct the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices. Second, we supervise banks and other financial institutions. Third, we maintain the stability of the financial system and contain systemic risk that may arise in financial markets.And finally, we provide certain financial services to the US government, US financial institutions, and foreign official institutions. We play a major role in operating and overseeing the nation’s payments systems.

Lots of people know the Fed simply as the institution that sets interest rates. Monetary policy actually is set by the Federal Open Market Committee (FOMC), which is composed of the members of the Fed’s Board of Governors and the presidents of five Federal Reserve Banks, including the Federal Reserve Bank of New York. The FOMC formulates monetary policy by setting a target for the federal funds rate, the interest rate that banks charge one another for short-term loans.

As stipulated by law, the aim of monetary policy is “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” One way the Fed accomplishes this is by changing its target for the federal funds rate. Such changes affect other short-term and long-term interest rates,including those on Treasury securities, corporate bonds, mortgages, and other loans. In turn, changes in these variables will affect households’ and businesses spending decisions, thereby affecting growth in aggregate demand and the economy. The FOMC holds eight regularly scheduled meetings per year, which garner a lot of attention from investors and the media. At these, the committee reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.

Story appeared in the November 2015 issue of American magazine.