Functions of the Federal Reserve System

Functionsof the Federal Reserve System

Functionsof the Federal Reserve System

TheFederal Reserve System refers to a central banking system used by theUnited States to monitor and control the monetary market and theactivities of the financial institutions. The system was created in1913 by the U.S. Congress (Federal Reserve Bank, 2015). The mainintentions of creating the federal system included the provision ofthe U.S. with a more flexible, safer, and stable financial as well asmonetary system. The initial decision to establish the FederalReserve System was motivated by the economic crisis, but itsfunctions have been expanded over the years. This paper will focus onthe key functions of the Federal Reserve System and the effect of itspolicies on institutions and the financial market.

Functionsof the Federal Reserve System

Implementationof the monetary policy

Boththe fiscal and monetary policies are determined by the executive andlegislative arms of the government, but these policies areimplemented by the Federal Reserve System. The main objectives of themonetary and fiscal policies include protection of the purchasingpower of the dollar, sustain economic growth, promote the balance oftrade in the long-run, and increase employment opportunities (FederalReserve Bank of Atlanta, 2015). The Federal Reserve System pursuesthese objectives through its day-to-day actions that are intended toinfluence the cost as well as the availability of credit money. TheFederal Reserve uses three major tools to implement the provisions ofthe monetary policy, which include the open market policy, reserverequirements, and the discount rates.

Regulationand supervision functions

Financialinstitutions (including the banks) are guided by differentregulations that are designed to ensure that they are able to servedepositors and adhere to the banking principles. Federal ReserveSystem shares the responsibility of designing these regulations andensuring that they are followed by other regulatory agencies (FederalReserve Bank of Atlanta, 2015). The Board of Governors is responsiblefor writing down the rules that allow or restrict banks fromdifferent activities. In addition, the federal reserve system of theU.S. is empowered by legislation to supervise and oversee activitiesof foreign companies and banks that have significant influence on theU.S. financial system. The Federal Reserve System carries out itssupervisory role by performing on-site examinations and evaluatingreports prepared by commercial banks.

Offeringservices to the depository firms

Reservebanks, being part of the central bank, are directly involved in thepayment system, but their participation in the payment system isintended to ensure that the system operates safely and efficiently.The Federal Reserve banks do not offer the payment system, whichmeans that they charges do not exceed their cost of rendering thepayment services (Federal Reserve Bank of Atlanta, 2015). The reservesystem has been serving credit unions, loan associations, mutualsaving banks, and banks that are not members of the Federal ReserveSystem. Some of the key services offered to depository institutionsinclude safeguarding deposits, provision of cash, transfer of funds,and acceptance of deposits.

Effectsof Federal Reserve System

TheFederal Reserve systems affect institutions (such as banks) bycontrolling their actions and operations. This is achieved throughthe implementation of the monetary policies that are formulated bythe legislature and the executive. The Federal Reserve alsodetermines the amount that individual financial institutions cad lendby determining the amount of reserve (Federal Reserve EducationalOrganization, 2015). The reserve may also increase or decrease thelending capacity of the financial institutions indirectly through thesale or the purchase of different financial instruments, such as thetreasury bonds. By regulating the amount that is available forlending to the public and setting margins for banks and borrowers,the Federal Reserve board is able to enhance the stability of thefinancial market.

TheFederal Reserve System influence changes in the interest rate and thegrowth in the entire economy by setting the federal funds rate. TheFederal Open Market Committee (FOMC) is responsible for thedetermination of the federal funds rate, which varies from onedepository institution to another (Federal Reserve Bank, 2015). Bysetting optimum federal funds rate and applying the suitable monetarypolicy tools (such as discount window lending, open marketoperations, and reserve requirements), the FOMC and Federal Reserveare able to moderate the long-term interest rate, which in turnstabilizes the national economy, maximize employment, and stabilizeprices in the market. For example, a moderately low federal fundsrate boosts economic growth rate by lowering the rate at whichmembers of the public can access loans for investment, but anextremely low rate can cause inflation (Federal Reserve Bank, 2015).A high rate, on the other hand, enhances the sustainability ofeconomic growth, but an extremely high rate hinders growth since itforces the lending institutions to offer investment loans toborrowers at a higher rate.


TheFederal Reserve System plays a key role in stabilizing the growth ofthe national economy. This is accomplished the three key functions ofthe system, which include the implementation of the monetary policy,maintaining the efficiency of the payment system, and effectivesupervision as well as the regulation of the banking operations. TheFederal Reserve also regulates the economic growth through thefederal fund rate, which determines the interest rate at whichcommercial banks will lend investment funds to investors.


FederalReserve Bank (2015). Monetarypolicy: What is monetary policy?Richmond, VA: Federal Reserve Bank.

FederalReserve Bank of Atlanta (2015). The Fed’s functions. FederalReserve Bank of Atlanta.Retrieved August 23, 2015, from

TheFederal Reserve Educational Organization (2015). Monetary policybasics. TheFederal Reserve Educational Organization.Retrieved August 23, 2015 from