Purpose Overview of the Federal

Reserve System
The Federal Reserve performs five key functions
in the public interest to promote the health of
the U.S. economy and the stability of the U.S.
financial system.

1
The U.S. Approach to Central Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

The Decentralized System Structure and Its Philosophy . . . . . . . . . . . . . . . . 4

The Reserve Banks: A Blend of Private and

Governmental Characteristics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

vi Overview of the Federal Reserve System

 T he Federal Reserve System is the central bank of the United States.
It performs five general functions to promote the effective operation of
the U.S. economy and, more generally, the public interest. The Federal
Reserve
• conducts the nation’s monetary policy to promote maximum
employment, stable prices, and moderate long-term interest rates in
the U.S. economy;
• promotes the stability of the financial system and seeks to
minimize and contain systemic risks through active monitoring and
engagement in the U.S. and abroad;
• promotes the safety and soundness of individual financial
institutions and monitors their impact on the financial system as a
whole;

Figure 1.1. The Federal Reserve System

The Federal Reserve is unique among central banks. By statute, Congress provided for a central banking system with public
and private characteristics. The System performs five functions in the public interest.

1
U.S. The Federal
Central Bank Reserve System

3 Federal 12 Federal Federal

Key Reserve Board Reserve Open Market
Entities of Governors Banks Committee

Helping Fostering Promoting

5 Conducting Supervising
maintain the payment and consumer
the nation’s and regulating
Key monetary
stability of
financial
settlement protection and
Functions the financial system safety community
policy institutions
system and efficiency development

The Federal Reserve System Purposes & Functions 1

• fosters payment and settlement system safety and efficiency
through services to the banking industry and the U.S. government
that facilitate U.S.-dollar transactions and payments; and
• promotes consumer protection and community development
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 Federal Reserve
was established to
serve the public
interest.

The U.S. Approach to Central Banking

The framers of the Federal Reserve Act purposely rejected the concept
of a single central bank. Instead, they provided for a central banking
“system” with three salient features: (1) a central governing Board,
(2) a decentralized operating structure of 12 Reserve Banks, and
(3) a combination of public and private characteristics.

Although parts of the Federal Reserve System share some characteristics

with private-sector entities, the Federal Reserve was established to serve
the public interest.

There are three key entities in the Federal Reserve System: the Board
of Governors, the Federal Reserve Banks (Reserve Banks), and the
Federal Open Market Committee (FOMC). The Board of Governors, an
agency of the federal government that reports to and is directly
accountable to Congress (figure 1.2), provides general guidance for
the System and oversees the 12 Reserve Banks.

2 Overview of the Federal Reserve System

Figure 1.2. Three key entities, serving the public interest
The framers of the Federal Reserve Act developed a central banking system that would broadly represent the public interest.

CONGRESS
oversees the Federal Reserve System
and its entities.

FEDERAL OPEN MARKET

COMMITTEE
consists of the members of the Board of FEDERAL RESERVE BANKS
Governors and Reserve Bank presidents. BOARD OF GOVERNORS are the operating arms of the
The Chair of the Board is the is an independent agency of the
Federal Reserve System and are
FOMC Chair. federal government.
supervised by the Board of Governors.

Within the System, certain responsibilities are shared between the Board
of Governors in Washington, D.C., whose members are appointed by
the President with the advice and consent of the Senate, and the Federal
Reserve Banks and Branches, which constitute the System’s operating
presence around the country. While the Federal Reserve has frequent
communication with executive branch and congressional officials, its
decisions are made independently.

The Federal Reserve System Purposes & Functions 3

The Decentralized System
Structure and Its Philosophy
In establishing the Federal Reserve System, the United States was divided
geographically into 12 Districts, each with a separately incorporated
Reserve Bank. District boundaries were based on prevailing trade regions
that existed in 1913 and related economic considerations, so they do not
necessarily coincide with state lines (figure 1.3).

As originally envisioned, each of the 12 Reserve Banks was intended

to operate independently from the other Reserve Banks. Variation was
expected in discount rates—the interest rate that commercial banks

Figure 1.3. Twelve Federal Reserve Districts operate independently but with supervision
Federal Reserve District boundaries are based on economic considerations; the Districts operate independently but under the
supervision of the Federal Reserve Board of Governors.

4 Overview of the Federal Reserve System

 were charged for borrowing funds from a Reserve Bank. The setting of
a separately determined discount rate appropriate to each District was
considered the most important tool of monetary policy at that time.
The concept of national economic policymaking was not well devel-
oped, and the impact of open market operations—purchases and sales
of U.S. government securities—on policymaking was less significant.

Revisions to the As the nation’s economy became more integrated and more complex,

Federal Reserve through advances in technology, communications, transportation, and

financial services, the effective conduct of monetary policy began to re-
Act in 1933 and
quire increased collaboration and coordination throughout the System.
1935 created
This was accomplished in part through revisions to the Federal Reserve
the modern-day Act in 1933 and 1935 that together created the modern-day FOMC.
Federal Open
Market Committee. The Depository Institutions Deregulation and Monetary Control Act
of 1980 (Monetary Control Act) introduced an even greater degree
of coordination among Reserve Banks with respect to the pricing of
financial services offered to depository institutions. There has also been
a trend among Reserve Banks to centralize or consolidate many of their
financial services and support functions and to standardize others. Re-
serve Banks have become more efficient by entering into intra-System
service agreements that allocate responsibilities for services and func-
tions that are national in scope among each of the 12 Reserve Banks.

The Federal Reserve System Purposes & Functions 5

The Reserve Banks: A Blend of Private
and Governmental Characteristics
Pursuant to the Federal Reserve Act, each of the 12 Reserve Banks is
separately incorporated and has a nine-member board of directors. Is Reserve Bank stock like
regular corporate stock?
The 12 regional Federal
Commercial banks that are members of the Federal Reserve System
Reserve Banks issue shares
hold stock in their District’s Reserve Bank and elect six of the Reserve of stock to member banks.
Bank’s directors; three remaining directors are appointed by the Board Owning Reserve Bank stock
is, however, quite different
of Governors. Most Reserve Banks have at least one Branch, and each
from owning stock in a pri-
Branch has its own board of directors. Branch directors are appointed vate company. The Reserve
by either the Reserve Bank or the Board of Governors. Banks are not operated for
profit, and ownership of
a certain amount of stock
Directors serve as a link between the Federal Reserve and the private is, by law, a condition of
sector. As a group, directors bring to their duties a wide variety of ex- membership in the System.
The stock may not be sold,
periences in the private sector, which gives them invaluable insight into
traded, or pledged as secu-
the economic conditions of their respective Federal Reserve Districts. rity for a loan, and dividends
Reserve Bank head-office and Branch directors contribute to the Sys- are, by law, paid to member
banks at a maximum rate of
tem’s overall understanding of the economy.
6 percent, determined in part
by each member bank’s total
The Federal Reserve is not funded by congressional appropriations. assets.

Its operations are financed primarily from the interest earned on the
­securities it owns—securities acquired in the course of the Federal
Reserve’s open market operations. The fees received for priced ­services
provided to depository institutions—such as check clearing, funds
transfers, and automated clearinghouse operations—are ­another
source of income; this income is used to cover the cost of those ser-
vices. After payment of expenses and transfers to surplus (limited to an
aggregate of $10 billion), all the net earnings of the Federal Reserve
Banks are transferred to the U.S. Treasury (figure 1.4).

6 Overview of the Federal Reserve System

 Despite the need for coordination and consistency throughout the
Federal Reserve System, geographic distinctions remain important.
Effective monetary policymaking requires knowledge and input about
regional differences. For example, two directors from the same indus-
try may have different opinions regarding the strength or weakness of
that sector, depending on their regional perspectives. The decentralized
structure of the System and its blend of private and public characteris-
tics, envisioned by the System’s creators, therefore, remain important
features today.

Figure 1.4. Federal Reserve net earnings are paid to the U.S. Treasury
The Federal Reserve transfers its net earnings to the U.S. Treasury.

Billions of
dollars
$100
$96.9 $97.8*

$88.4
$80
$79.3 $79.6
$75.4

$60

$47.4
$40
$34.6
$31.7
$29.1
$20 $22.9 $21.5
$18.1

0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

* Does not include $19.3 billion also transferred to the U.S. Treasury from Reserve Bank capital surplus per the Fixing
America’s Surface Transportation Act.
Source: Federal Reserve Board news release, January 10, 2013 (available in the News & Events section of the Federal Reserve
Board’s website, [Link]).

The Federal Reserve System Purposes & Functions 7