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Updated June 14, 2022
Introduction to Financial Services: The Federal Reserve
Structure of the Federal Reserve
member banks. Membership is mandatory for federally
The Federal Reserve Act of 1913 (12 U.S.C. 221 et seq.)
chartered banks but optional for state-chartered banks. The
created the Federal Reserve (Fed) as the nation’s central
stock pays dividends of 6% for banks with less than $10
bank. The Fed is composed of 12 regional Federal Reserve
billion in assets and the lower of 6% or the 10-year
banks overseen by a Board of Governors in Washington,
Treasury yield for banks with more than $10 billion in
DC. Figure 1 illustrates the city in which each bank is
assets. Member banks choose two-thirds of the boards at the
headquartered and the area of each bank’s jurisdiction.
regional Fed banks.
The board is composed of seven governors nominated by
Responsibilities of the Federal Reserve
the President and confirmed by the Senate. The President
The Fed’s responsibilities fall into four main categories:
selects (and the Senate confirms) a chair and two vice
monetary policy, lender of last resort, regulation of certain
chairs from among the governors, one of whom is
banks and other financial firms, and provision and oversight
responsible for supervision. The governors serve
of certain payment systems.
nonrenewable 14-year terms, but the chair and vice chairs
serve renewable four-year terms. Board members are
Monetary Policy. The Fed’s primary monetary policy
chosen without regard to political affiliation. Regional bank
instrument is the federal funds rate (the overnight bank
presidents are chosen by their boards with the approval of
lending rate). The Fed influences interest rates to affect
the Board of Governors.
interest-sensitive spending on capital investment, consumer
durables, and housing. Interest rates also indirectly
Figure 1. Federal Reserve Districts
influence the value of the dollar and, therefore, spending on
exports and imports. The Fed reduces rates to stimulate
economic activity and raises rates to slow activity.
Monetary policy is considered a blunt instrument that
cannot be targeted to affect specific regions, certain
industries, or the income distribution.
Formerly, the Fed targeted the federal funds rate primarily
through open market operations—the purchase and sale of
U.S. Treasury securities, mainly from primary dealers (who
specialize in trading government securities), in the
secondary market. The Fed holds these securities as assets
on its balance sheet. Often, these transactions were made on
a temporary basis using repurchase agreements, known as
Source: Federal Reserve.
repos. Since the 2007-2009 financial crisis, the Fed has
primarily used a new method for targeting interest rates that
In general, policy is formulated by the board and carried out
relies on banks maintaining large reserves at the Fed and
by the regional banks. Monetary policy decisions, however,
paying banks interest on those reserves. The Fed sets that
are made by the Federal Open Market Committee (FOMC),
interest rate to influence the federal funds rate. In addition,
which is composed of the seven governors, the president of
monetary policy can involve foreign exchange operations,
the New York Fed, and four other regional bank presidents.
although these are rare. Open market and foreign exchange
Representation for these four seats rotates among the other
operations are conducted by the New York Fed per the
11 regional banks. The FOMC meets at least every six
FOMC’s directives. The Fed influences growth in the
weeks to review the stance of monetary policy.
money supply through its control over bank reserves and
currency in circulation, which are largely liabilities on its
The Fed’s budget is not subject to congressional
balance sheet.
appropriations or authorizations. The Fed is funded by fees
and the income generated by securities it owns. Its income
During the financial crisis, the Fed reduced the federal
exceeds its expenses, and it remits most of its net income to
funds rate to zero and conducted large-scale asset purchases
the Treasury, where it is used to reduce the federal debt.
of Treasury- and mortgage-backed securities from 2008 to
2014—known as quantitative easing (QE)—that increased
The Fed’s capital consists of stock and a surplus. The
the size of its balance sheet. Following a period when rates
surplus is capped at $6.825 billion by law. (Congress
rose and the balance sheet shrunk, the Fed began to cut
reduced the Fed’s financial surplus as a budgetary “pay for”
rates and expand its balance sheet again in 2019. At the
in P.L. 114-94, P.L. 115-123, and P.L. 115-174.) Private
onset of the pandemic, the Fed swiftly lowered interest rates
banks regulated by the Fed buy stock in the Fed to become
to zero and increased its use of QE and repos to boost
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Introduction to Financial Services: The Federal Reserve
liquidity. This caused the balance sheet to double in 18
regularly conduct other hearings on the Fed (12 U.S.C.
months, which has boosted Fed remittances to the Treasury.
225b and 247b).
Lender of Last Resort. Despite their name, Federal
Policy Issues
Reserve banks do not carry out any banking activities, with
Monetary Policy Normalization and Inflation. In 2021
one limited exception: The Fed traditionally acts as lender
and 2022, inflation has risen to levels last seen in the 1980s.
of last resort by making short-term, collateralized loans to
This has led to debate over how quickly the Fed should
banks through its discount window. The Fed generally sets
normalize monetary policy (i.e., remove the extraordinary
the discount rate charged for these loans above market
stimulus from the pandemic). In March 2022, the Fed began
rates. In normal market conditions, the Fed’s lending
raising interest rates and ended its asset purchases. In June
operations are minimal. In crises, the Fed has emergency
2022, the Fed allowed its balance sheet to begin to
authority to extend its lender-of-last-resort function to
gradually shrink. However, the Fed expects additional rate
nonbank firms and markets. In response to the pandemic,
hikes will be needed in 2022 to restore low inflation, and
the Fed announced an alphabet soup of emergency
critics question whether those hikes will be sufficient.
programs to stabilize the financial system and assist entities
cut off from credit markets. The CARES Act (P.L. 116-
Diversity. Some Members of Congress have expressed
136) provided at least $454 billion to support some of these
concern over a lack of diversity at the Fed and in the
programs, including the Main Street Lending Program and
banking sector and believe that the Fed could do more to
the Municipal Liquidity Facility. The programs were much
eliminate racial disparities. The Dodd-Frank Act (P.L. 111-
smaller than their announced size and expired in 2020.
203) created Offices of Minority and Women Inclusion for
the Federal Reserve System. H.R. 2543 would require the
Regulation. The Fed regulates bank holding companies
Fed to exercise its duties to foster the elimination of (and
(including the largest banks), some foreign banks, and some
testify on its efforts to eliminate) racial disparities. H.R.
state-chartered banks. The Fed’s regulatory responsibilities
2516 would require the Fed (and other bank regulators) to
overlap with those of other bank regulators—the Consumer
include diversity in their supervisory ratings of banks.
Financial Protection Bureau (CFPB), the Federal Deposit
Insurance Corporation (FDIC), and the Office of the
Central Bank Digital Currency (CBDC). With the rise of
Comptroller of the Currency (OCC). The Fed shares
private digital currencies, such as Bitcoin, some have called
responsibility for maintaining financial stability with the
for the Fed to create a “digital dollar” or CBDC. The Fed
Financial Stability Oversight Council (FSOC) and its
has not yet taken a position on the desirability of a CBDC
members. (FSOC is a council of regulators, including the
but “does not intend to proceed with issuance of a CBDC
Fed, headed by the Treasury Secretary.) The Fed
without clear support from the executive branch and from
participates in intergovernmental fora, such as the Financial
Congress, ideally in the form of a specific authorizing law.”
Stability Board and the Basel Committee on Banking
Critics question whether the costs of introducing a CBDC
Supervision, alongside other U.S. agencies.
would outweigh the benefits. Policymakers have debated
how to balance privacy and preventing illicit activity and
Payment Systems. The Fed operates key payment systems,
whether individuals should be able to store CBDCs in
including check clearing and interbank transfers, and
personal accounts at the Fed.
oversees some private-sector payment systems. The Fed is
planning to launch FedNow, a real-time payment system for
Climate Change. In 2020, the Fed joined the Network for
instantaneous payment settlement, in 2023. It also acts as
Greening the Financial System, a group of over 80 central
the federal government’s fiscal agent—federal receipts and
banks and regulators focused on climate-related risks. In
payments flow through Treasury’s accounts at the Fed.
2021, the Fed created two internal committees related to
climate risk and announced they were developing climate
Mandate and Congressional Oversight
scenario analysis to measure banks’ exposure to climate
Congress has delegated monetary policy to the Fed but
risk. Some critics believe the Fed should be doing more to
conducts oversight to ensure the Fed meets its statutory
combat climate change. Other critics believe that climate
mandate of “maximum employment, stable prices, and
change is outside of the Fed’s mission and the Fed lacks the
moderate long-term interest rates” (12 U.S.C. 225a). The
tools to effectively address it.
Fed has defined stable prices as a longer-run goal of 2%
inflation. In 2020, the Fed pledged to allow inflation to run
CRS Resources
slightly above 2% to make up for inflation previously
CRS In Focus IF11751, Introduction to U.S. Economy:
falling short of 2%.
Monetary Policy, by Marc Labonte
The Fed is more independent from Congress and the
CRS Report R46411, The Federal Reserve’s Response to
Administration than most agencies are. Economists have
COVID-19: Policy Issues, by Marc Labonte
justified the Fed’s independence on the grounds that
monetary policy decisions that are insulated from short-
CRS Report R46890, Inflation in the Wake of COVID-19,
term political pressures result in better economic outcomes.
by Marc Labonte and Lida R. Weinstock
There is an inherent trade-off between independence and
accountability, however. The chair and vice chair for
CRS Report R46850, Central Bank Digital Currencies:
supervision are statutorily required to testify semi-annually
Policy Issues, by Marc Labonte and Rebecca M. Nelson
before the committees of jurisdiction, and the committees
https://crsreports.congress.gov
Introduction to Financial Services: The Federal Reserve
IF10054
Marc Labonte, Specialist in Macroeconomic Policy
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