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Yahoo U: The Federal Reserve explained

In this week's Yahoo U, Yahoo Finance’s Brian Cheung breaks down the Federal Reserve and how the U.S. central bank system functions.

Video Transcript

ZACK GUZMAN: The Federal Reserve has obviously played a large part in the economic response to the coronavirus pandemic. And it's increasingly in focus as we come out on the other side. So in this week's "Yahoo U," we found it only fitting to break down why the Fed is so important. Here is Yahoo Finance's Brian Cheung.

BRIAN CHEUNG: Class is in session. And you've probably seen the headlines before. The Fed lowers interest rates, the Fed raises interest rates. The Fed does some stuff because, you know, the economy. But to understand why the Fed is important, it's important to know what the Fed does and how it's structured.

In 1913, the Federal Reserve Act was signed into law, creating the nation's central bank. And Congress gave the Fed two major objectives stable prices, so no crazy inflation or deflation, and maximum employment, making sure there are enough jobs for workers and enough workers for jobs.

The central bank's board of governors, so think mission control, is based in Washington DC. The Fed chair presides over the board, which can have up to six other governors. But with a country as big as ours with so many different regional economies the Fed also has 12 outposts scattered across the country, referred to as reserve banks.

Each of these Reserve banks has a president. The 12 presidents plus the seven members of the board in DC make up the Federal Open Market Committee, which meets eight times every year to set monetary policy. And one primary way the Fed conducts monetary policy is by setting targets on interest rates. As the bankers bank, the Fed allows US banks to park money overnight. So lower interest rates spur more borrowing and lending, in theory, stimulating the economy if the economy looks like it might overheat, think runaway inflation, the Fed can raise interest rates, in theory, pulling back on economic activity.

The Fed has also relied on its balance sheet by buying US government bonds and mortgage backed securities to support liquidity in major markets. And with the US and the US dollar as the rock of the global economy, the Fed remains the world's most important central bank. Its actions have ripple effects on ordinary consumers all the way up to Forex markets in countries on the other side of the world, which makes it all the more interesting and important to know about.

That's this week's "Yahoo U." Class is dismissed.

AKIKO FUJITA: Brian Cheung breaking down the Fed for us in this week's "Yahoo U."