An in-depth look at the Federal Reserve’s structure, goals, policies, influence over markets, and issues like moral hazard created by repeated government bailouts and stimulus.
The Federal Reserve is arguably the most influential institution in the global financial system, yet its workings remain mysterious to many. In this in-depth blog post, We’ll provide an insider’s perspective on the origins, goals, policies, and challenges facing the U.S. central bank.
The Fed’s Carefully Balanced Structure
The Federal Reserve System, America’s central bank, was created in 1913 after decades of debates over centralizing money and power. Its complex structure aimed to balance government and private banking interests. The system consists of:
- 12 regional Federal Reserve banks — Each has its own jurisdiction over local banks. The banks are controlled by local member banks.
- Board of Governors — 7 members appointed by the President. Includes the Chairman who has a 4-year term.
- Federal Open Market Committee (FOMC) — 12 members make key policy decisions. Includes the 7 Governors and 5 regional bank presidents.
This balanced composition was designed to ensure Fed independence from political pressure and Wall Street influence. The Fed also returns profits to the Treasury, not shareholders.
The Fed’s Twin Goals: Stable Prices and Maximum Employment
The Fed has a dual mandate to promote price stability and maximum employment. It mainly controls the federal funds rate — the interest rate banks charge each other for overnight loans. This influences broader credit conditions and money supply in the economy.
To support growth in crises, the Fed has turned to unconventional policies like quantitative easing (QE), where it buys large amounts of bonds to lower longer-term interest rates. This flooded markets with liquidity after 2008.
The Fed as a Market Mover and Shaker
The Fed holds enormous sway over financial markets. When it signals tighter monetary policy, stocks often fall on expectations of higher borrowing costs and squeezed profits. Meanwhile, loose policy tends to push asset prices higher as investors take on more risk.
Former Fed Chair Paul Volcker showed the Fed’s power and independence by tightening aggressively to tame inflation despite massive protests. This cemented trust in the central bank. The Fed also communicates its plans clearly through projections and speeches.
Moral Hazard and Market Distortions
However, repeated Fed rescues create moral hazard — companies take excessive risks knowing the Fed will intervene. Its extraordinary policies may heighten volatility and distort asset prices. Reconciling stimulus with preventing market excesses is an ongoing dilemma.
While the Fed faces challenges, its unique position and policymaking process remain admired globally. Understanding the non-political and complex nature of the Fed provides key insights for investors on navigating markets.
