The Federal Reserve is the central bank of the United States, created by Congress in 1913 after a series of banking panics. It is often described as the most powerful economic institution in the world, and also one of the least understood.
The mandate
Congress has directed the Fed to promote maximum employment, stable prices and moderate long-term interest rates. The first two, known as the dual mandate, drive almost every decision. Since 2012 the Fed has defined stable prices as 2% annual inflation, measured by the PCE price index.
Who decides
Monetary policy is set by the Federal Open Market Committee. It has twelve voting members: the seven governors of the Federal Reserve Board in Washington, the president of the Federal Reserve Bank of New York, and four of the other eleven regional bank presidents on a rotating basis. It meets eight times a year. Governors are appointed by the president and confirmed by the Senate to 14-year terms; the chair serves a four-year term. Long terms are meant to insulate decisions from the election cycle.
The main tool: the federal funds rate
The FOMC sets a target range for the federal funds rate, the rate banks charge each other for overnight loans. It steers that rate mainly by setting the interest it pays banks on reserves held at the Fed. Changes ripple outward: to credit card and auto loan rates quickly, to mortgage rates and bond yields through expectations about where rates are headed.
- Raising rates makes borrowing more expensive, slows spending and hiring, and brings inflation down, at some risk of recession.
- Cutting rates does the opposite, supporting jobs at some risk of higher inflation.
The balance sheet
During the 2008 financial crisis and the 2020 pandemic, with short-term rates near zero, the Fed bought trillions of dollars in Treasury and mortgage-backed securities to push down long-term rates, a policy known as quantitative easing. Letting those holdings shrink, called quantitative tightening, works in the opposite direction.
The other jobs
- Lender of last resort. The Fed lends to banks through its discount window and has set up emergency programs in crises.
- Bank supervision. It oversees bank holding companies and many state banks, alongside other regulators.
- Payments. It runs core payment systems, including the FedNow instant payment service launched in 2023.
What the Fed can’t do
The Fed does not set tax or spending policy, cannot target individual prices like gas or groceries, and has little influence over supply shocks such as wars or pandemics except by cooling or supporting overall demand. When inflation comes from supply, rate hikes work slowly and with real costs to employment, which is why its decisions are so contested.