A lot of media attention has been devoted to the Federal Reserve, the potential recession and the warning signs of inflation. As we approach the next meeting of the Federal Reserve and digest their action to buoy the bond market today, it is a good time to review what they do and how they influence the US economy.
What is the Federal Reserve?
The Federal Reserve, or "The Fed" as it is commonly referred to, functions as the central bank of the United States. Through experience, most countries have decided that an unregulated, decentralized banking system is unlikely to provide the optimum conditions for economic welfare. After a severe money panic in 1907, a national monetary commission was established by Congress. Their recommendations led to the Federal Reserve Act of 1913 which created the Federal Reserve System (which is actually the 3rd central bank in US history).
In essence, the Federal Reserve is an independent institution, which can not be abolished or rendered ineffective by the President or Congress. Its role and function can only be altered via specific legislative action by Congress. This further insulates the system from political pressures, which has its critics and proponents.
The Federal Reserve reports annually to the House of Representatives and twice annually on its monetary policy plans to the banking committees of Congress. In addition, the Federal Open Market Committee holds eight regularly schedule meetings per year. It is at these meetings that the Committee reviews economic conditions, determines the appropriate stance of monetary policy and assesses the risks to price stability and sustainable economic growth.
What does the Federal Reserve do?
The Federal Reserve issues Federal Reserve Notes, i.e. paper and coin currency. Their primary role however is to promote the economic welfare of the nation. Specifically, the Fed's role falls into four areas:
1) It conducts the nation's monetary policy to pursue stable prices and employment.
2) It supervises and regulates banking institutions to ensure the soundness of the of the financial system and protect consumers (administers ECOA, TIL, HMDA).
3) It maintains the stability of the financial system by containing some of the risks that arise in the financial markets.
4) It provides certain financial services to the government, public, financial and foreign institutions by operating the nation's check, wire and electronic payment systems.
They accomplish this via mechanisms that are designed to control the money supply. These are: altering the reserve requirements of banks (the proportion of deposits that banks must keep on hand), open market operations (the purchase or sale of securities to alter reserves in the banking system) and the discount rate. Of these, the main tool used is the open market operations implemented by the Federal Open Market Committee, called the FOMC.
It is important to note that the Federal Reserve does not directly affect the interest rate on mortgages. A decrease in the Federal Funds rate can lead to a decrease, increase or no change at all in fixed mortgage rates. So although the FED and FOMC have can control US monetary policy and influence our economy they can not help homebuyers by lowering interest rates... only try to create economic conditions that benefits both consumers and businesses.
Roland Carrillo, PhD
Branch Manager
VanDyk Mortgage
Email: rjcarrillo@gmail.com
Website: http://www.mymortgageanalysis.com/
