Fed Up with Not Understanding the Fed?

Physician's Money DigestFebruary28 2003
Volume 10
Issue 4

The Federal Reserve Act of1913 established the FederalReserve System to regulatethe US monetary and banking system.Its main functions include: regulatingthe national money supply,setting reserve requirements formember banks, supervising the printingof currency, and acting as a clearinghousefor the transfer of fundsthroughout the banking system.


The fed is comprised of 12 regionalFederal Reserve Banks, their 24branches, and all national and somestate banks included in the system.The Federal Reserve Banks monitorthe commercial and savings banks toensure they follow regulations, act asdepositories, provide money transfers,and perform other services.

The 7 members of the system'sgoverning board, known as theFederal Reserve Board (FRB), areappointed by the US president andconfirmed by the Senate. Onceappointed, board members remainfor a 14-year term and oversee reserverequirements for the system,establish bank regulations, set bankloaninterest rates, and regulate thepurchase of securities on margin.

Probably the most familiar componentof the fed is the Federal OpenMarket Committee (FOMC). Thiscommittee sets interest rate and creditpolicies for the fed. The FOMC has12 members: 7 FRB members and 5regional Federal Reserve Bank presidents.The 4 presidents are picked ona rotating basis. The fifth position isreserved for the president of theFederal Reserve Bank of New York,who is a permanent member. In additionto their other duties, the FOMCmeets to determine if there is a needto increase or decrease interest rates.


If the nation's economy expandsrapidly, historically, the threat ofinflation becomes a worry for consumers.Inflation (ie, the generalincrease in the price of services andgoods) lowers consumers' purchasingpower. To fight inflation, the fedmay elect to increase interest ratesor "tighten" interest rates.

By tightening interest rates, thefed decreases the amount of moneyavailable to the national banking system.For example, when the fedincreases member banks' interestrates, banks increase their lendingrates—making borrowed moneymore expensive for businesses andconsumers. By making borrowedmoney more expensive, the fed hopesto slow inflation by slowing down therate at which money is spent.

When the economy is draggingand needs an extra monetary boost,the fed "loosens" the nation's moneysupply by decreasing lending rates.By lowering these rates, the fedmakes more money available to thenation's banks. Consumers andbusinesses can then borrow moneyat lower rates. The extra moneyhelps stimulate consumer spendingand promote economic growth.

Joseph F. Lagowskiis vice president,

investments, and a financial consultant with A.G.

Edwards in Hillsborough, NJ.

He welcomes questions or

comments at 800-288-0901 or

www.agedwards.com/fc/joseph.lagowski. This

article was provided by A.G. Edwards & Sons,

Inc, member SIPC.

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