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How the Federal Reserve Safeguards the Financial System


It has been said that behind the President of the United States, the chairman of the Federal Reserve is one of the most powerful people in Washington, if not the world. While other institutions may be older, when it comes to raw power and impact, few can match the scope and clout of the country's 100 year-old central bank.

For this installment of Investing 101, we take a look inside this esteemed institution for a look at how it works and what it does.

What is the Federal Reserve System and why does it exist?

Created by the Federal Reserve Act of 1913, the Fed, as it's known, has evolved and grown over the years but its primary structure, role and objective remains the same. Based in Washington but also represented nationally via a dozen regional reserve banks, the Fed's primary job is to ensure that our monetary and financial system are safe, flexible and stable.

To do so, the central bank focuses on four general areas: the supervision and regulation of banks, the administration of monetary policy, mitigating risk and crisis, and providing payment services to commercial banks, the government and official foreign institutions.

How does the Fed work?

The Fed is overseen by a seven-member Board of Governors, which is headed by a chairman (currently Ben Bernanke) who is appointed by the President every four years, as well as the presidents of the twelve regional banks who are responsible for activity in their districts.

In addition, the Fed conducts monetary policy via a group called the Federal Open Market Committee (or the FOMC) which exists to create conditions that will result in full employment while making sure prices (or inflation) remain stable, two objectives that often seem to conflict each other. Achieving this so-called dual mandate is not easy and the FOMC's primary tool to achieve it is to raise or lower interest rates.

The Fed is also charged with overseeing billions of daily payment transactions, ensuring the safety and stability of the system, and in rare times of crisis, serving as "the lender of last resort" to keep markets moving and liquid.

What does the Fed do?

In addition to its day-to-day oversight and monitoring activities, the FOMC meets eight times a year to assess the current state of the economy and financial system. A statement is made afterwards that outlines its current thinking and any actions that were taken or concerns that were raised. The Fed chairman also appears regularly before Congress to explain the board's thinking and address lawmaker's concerns. Additionally, current chairman Bernanke holds a quarterly press conference to answer questions for financial media.

The next FOMC statement will be released on September 18th at 2:00p EST.

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