What Is The Federal Reserve?

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You've probably heard a lot lately about the Federal Reserve, commonly referred to as "the Fed". Recent economic news has focused on the Fed raising interest rates. It was also announced this week that President Bush has nominated Ben Bernanke to become the next chairman of the Federal Reserve. If confirmed, Bernanke will succeed current chairman Alan Greenspan after his term expires in January next year.But what is the Federal Reserve; what does it do; and how does it affect the nation's economy?The Federal ReserveThe Federal Reserve was founded by Congress to provide the country with a stable, yet flexible monetary and financial system. Its main purposes are to:Conduct the nation's monetary policySupervise and regulate banking institutionsMaintain financial stability and contain financial risk in the marketsProvide financial services to the U.S. government, foreign official institutions and "depository institutions" (financial institutions that obtain funds through deposits from the public, like commercial banks, savings and loans, savings banks and credit unions)The Federal Reserve Act was passed in 1913 "to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes."*The objectives of the Federal Reserve include: "economic growth in line with the economy's potential to expand; a high level of employment; stable prices (that is, stability in the purchasing power of the dollar); and moderate long-term interest rates."*Structure of the Federal ReserveThe Federal Reserve is run by a Board of Governors and 12 regional Federal Reserve banks which are responsible for regulating financial institutions and their activities, providing services to depository institutions and the federal government, and for making sure that consumers are treated fairly within the banking system.The Federal Open Market Committee (FOMC) is run by members from the Board of Governors and 5 presidents of the regional Federal Reserve banks, including the president of the Federal Reserve Bank of New York.The FOMC supervises open market operations which the Fed uses to influence monetary policy by controlling the fed funds rate. The fed funds rate is the interest rate at which depository institutions lend balances to other depository institutions overnight.How the Fed's Policies Affect the EconomyIn a general sense, one of the Fed's main objectives is to ensure economic growth while controlling inflation.The FOMC tries to maintain the fed funds rate at a level where it will help the FOMC achieve its objectives. It will adjust the rate depending on current economic developments. The level of the fed funds rate affects short-term interest rates (rates on Treasury bills with maturities less than a year). Short-term interest rates, in turn, affect long-term interest rates (rates on Treasury bills with maturities greater than a year).When the Fed raises or lowers interest rates, it affects how strong the demand is for goods and services. By altering interest rates, the Fed is "altering borrowing costs, the availability of bank loans, the wealth of households, and foreign exchange rates."**In the housing market, when mortgage rates are low, housing becomes more affordable and the number of home purchases rises. Current homeowners tend to refinance more to take advantage of falling rates and the opportunity to lower their mortgage payment.Conversely, when mortgage rates rise, housing becomes less affordable and the number of home purchases may drop. For existing homeowners, the trend often reverses. As rates rise, homeowners with adjustable rate mortgages (like ARMs or HELOCs) often refinance into fixed-rate mortgages to insulate themselves from rising mortgage payments.For more than a year, the Fed's stance has been to fight inflation by raising short-term interest rates. They're expected to raise interest rates another quarter percent when they meet next week on November 1st. This will be the 12th consecutive time the Fed has raised rates; and they're expected to keep raising rates in the near future.If you currently have an ARM or a home equity line of credit (HELOC), it's probably a good time to think about locking in your rate for 15 or 30 years.Sources:* "The Federal Reserve System: Purposes and Functions", Board of Governors of the Federal Reserve System, Washington, D.C., 9th Edition, June 2005. http://www.federalreserve.gov/pf/pf.htm** "About the Fed", Federal Reserve Bank of San Francisco, 2005. http://www.frbsf.org/publications/federalreserve/monetary/affect.html  Mortgage News Home Current Headlines Next Article  Refinancing | Home Loans | Home Equity Loans | My Quicken Loans Login Mortgage News | Mortgage Rates | Mortgage Calculators | Apply Online Careers | Contact Us | Feedback | Site Map | Help | Search Security and Privacy | Disclosures and Licenses | Terms of Use © 2000 - 2005 Quicken Loans Inc., All rights reserved. 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