“The Fed,” as the system is often called, was established in 1913 by the U.S. government to regulate the economy by monetary policy. It does that by controlling the supply of money and the cost and availability of credit.

The Fed is headed by a Board of Governors. The Board’s seven members are appointed by the President of the United States and approved by the Senate. Nonetheless they serve overlapping fourteen-year terms and are largely independent of both Congress and the White House.

The Federal Reserve is the central banking system of the United States; it operates through twelve Federal Reserve Banks and twenty-five branches across the nation. All national banks and about 10 percent of state banks are members of the system.

When banks need money, they may borrow from the Federal Reserve System. Through its control of the flow of money and credit within the United States, the Fed attempts to pump more money into the economy when a recession threatens. In a time of rising prices and excessive spending, the Fed normally tries to tighten the supply of money and credit so that people will have less to spend.

The Fed works chiefly in four ways:

1. Open market operations. Banks lend money to people in relation to the amount of reserves the banks have on deposit with the Federal Reserve. When the Fed sells government bonds on the open market, they are purchased by individuals and commercial banks. When people take money out of the bank to buy bonds, or when the banks pay for the securities, the banks have fewer dollars on hand. The effect is to reduce bank reserves and tighten credit; banks then have less money to lend to people. Or, the Federal Reserve can buy government securities, banks have more cash to lend, and interest rates go down, which should encourage people to borrow money.
2. The Fed can raise or lower the “discount rate” that it charges member banks for loans. This affects interest rates in the economy generally. If the rate is lowered, banks borrow more from the Fed and have more money to lend to their customers.
3. It can raise or lower the size of the reserves that member banks must keep in the Federal Reserve banks against their deposits and thus tighten or expand credit. For example, if the Fed wants to speed up the growth of the economy, it can lower the reserve requirement, which gives the banks access to more of their money to lend to customers.
4. It can raise or lower the “margin requirements” for persons buying securities. The margin requirement defines how much money people can borrow to purchase stocks.

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