The Federal Reserve System

Read these sections to learn about the Federal Reserve System's structure, functions, and goals. Also, identify and explain the tools of monetary policy and way money is created or destroyed through the purchase and sale of government bonds.

The Federal Reserve System

Learning Objectives

  1. Explain the primary functions of central banks.
  2. Describe how the Federal Reserve System is structured and governed.
  3. Identify and explain the tools of monetary policy.
  4. Describe how the Fed creates and destroys money when it buys and sells federal government bonds.

The Federal Reserve System of the United States, or Fed, is the U.S. central bank. Japan's central bank is the Bank of Japan; the European Union has established the European Central Bank. Most countries have a central bank. A central bank performs five primary functions: (1) it acts as a banker to the central government, (2) it acts as a banker to banks, (3) it acts as a regulator of banks, (4) it conducts monetary policy, and (5) it supports the stability of the financial system.

For the first 137 years of its history, the United States did not have a true central bank. While a central bank was often proposed, there was resistance to creating an institution with such enormous power. A series of bank panics slowly increased support for the creation of a central bank. The bank panic of 1907 proved to be the final straw. Bank failures were so widespread, and depositor losses so heavy, that concerns about centralization of power gave way to a desire for an institution that would provide a stabilizing force in the banking industry. Congress passed the Federal Reserve Act in 1913, creating the Fed and giving it all the powers of a central bank.

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