What is the Federal Reserve? What the Fed does

The Federal Reserve, usually called the Fed, is the central bank of the United States. Congress created it in 1913 to steady a banking system prone to panics. Today it has three main jobs: it steers short-term interest rates to keep inflation low and employment high, it supervises banks, and it acts as lender of last resort when the financial system is under strain.

In short

• The Fed is a system: a Board of Governors in Washington, 12 regional Reserve Banks, and the Federal Open Market Committee, which sets interest rate policy.
• Congress gave it a dual mandate, maximum employment and stable prices, which it reads as inflation of 2% a year over the longer run.
• Its main tool is the interest rate banks pay each other overnight; it also buys and sells bonds, lends to banks and supervises them.

Why was the Federal Reserve created?

Before 1913, the United States had no central bank, and banking panics came every decade or two. In the panic of 1907, depositors ran on banks and trust companies in New York, and the crisis was stopped mainly by the banker J.P. Morgan organizing private rescues. Lawmakers decided the country could not rely on one financier. On 23 December 1913, President Woodrow Wilson signed the Federal Reserve Act, which created a system of regional banks overseen by a board in Washington, a compromise between those who wanted a single central bank and those who feared one.

Year	What changed
1913	Federal Reserve Act creates the system
1935	Banking Act gives the Federal Open Market Committee its modern form
1951	An accord with the Treasury frees the Fed from holding down the government's borrowing costs
1977	Congress writes maximum employment and stable prices into the law
1979 – 1982	Under Paul Volcker, very high interest rates break double-digit inflation
2008	Rates go to near zero and the Fed begins buying bonds on a large scale
January 2012	The Fed states a 2% inflation goal in writing
August 2025	The Fed revises its statement of goals and strategy, its second review in five years

How is the Federal Reserve organized?

The Fed has three parts.

The Board of Governors is a federal agency in Washington with seven members. Each is nominated by the President and confirmed by the Senate. According to the Board, a full term is 14 years, with one term starting every two years, so no single President normally appoints a majority quickly. The chair and vice chairs are picked from among the governors for four-year terms.

The 12 Federal Reserve Banks each serve a region, from Boston to San Francisco. They supervise banks in their districts, run payment services, gather information on local economies and hold cash for banks. Each has its own president.

The Federal Open Market Committee, the FOMC, sets monetary policy. It has 12 voting members: the seven governors, the president of the New York Fed, and four of the other 11 Reserve Bank presidents, who take one-year turns. According to the FOMC's page, it holds eight scheduled meetings a year, and all 12 presidents take part in the discussions.

What is the Fed's dual mandate?

In 1977, Congress directed the Fed to promote "maximum employment, stable prices, and moderate long-term interest rates". Because steady low inflation tends to keep long-term rates moderate, the goals are usually called the dual mandate: jobs and prices.

The law doesn't define either goal in numbers. In January 2012, the FOMC said that inflation of 2% a year, measured by the price index for personal consumption expenditures, is most consistent with its mandate. The Fed's own explanation is that low, stable inflation lets households and businesses plan, save and borrow sensibly. Economists add that a little inflation, rather than none, leaves more room to cut interest rates in a downturn. Maximum employment has no fixed number, because the level of jobs the economy can sustain shifts with things like population and skills. When the two goals pull in different directions, the FOMC has to weigh them, which is why its decisions are often debated. The note on inflation explains why rising prices matter so much.

How does the Fed set interest rates? A worked example

The FOMC doesn't set the interest rate on mortgages or credit cards. It sets a target range for the federal funds rate, the rate banks charge each other for overnight loans of their reserves, the money they keep in accounts at the Fed. It steers that market rate mainly by setting the interest it pays banks on those reserves: few banks will lend overnight for less than the Fed itself pays them. The tools are listed on the Fed's policy tools page.

Follow one rise of 0.25 percentage points through the economy:

1. The FOMC raises its target range, say from 4.00–4.25% to 4.25–4.50%, and raises the rate it pays on reserves by the same amount.
2. Overnight rates between banks move up within hours.
3. Banks raise their prime rate, the base for many loans, which by custom sits 3 points above the top of the Fed's range: from 7.25% to 7.50%.
4. A credit card whose rate is tied to prime goes up by 0.25 points too. On a $10,000 balance carried all year, that's about $25 more in interest.
5. Savings accounts and certificates of deposit at many banks start paying a little more.

Long-term rates, such as on a 30-year mortgage, are set in bond markets and depend on what investors expect the Fed to do for years ahead, not just today. Higher borrowing costs cool spending, hiring and price rises; lower ones do the opposite, which is the idea explained in how interest rates work. The effects take months, often more than a year, to show up fully. Between March 2022 and July 2023, the FOMC raised its target from near zero to 5.25–5.50%, the fastest rise in four decades, to bring down the highest inflation since the early 1980s.

What else does the Fed do?

When short-term rates are already near zero, the Fed can buy government bonds and mortgage-backed securities in large amounts, known as quantitative easing. It pays for them by creating bank reserves, which pushes long-term rates down. It did this after 2008 and again in 2020, and later let those holdings shrink.

It supervises and regulates many banks, including the largest, setting how much capital they must hold and testing whether they could survive a severe recession. It lends to sound banks through its discount window when they are short of cash, so a run on deposits doesn't force a healthy bank to fail, which is the lender-of-last-resort role it was created for. It also runs payment systems that move trillions of dollars between banks, and it issues the paper dollars that make up part of the nation's money.

Still argued

How independent the Fed should be is a long-running debate. Its supporters, including most central bankers and many economists, argue that a central bank shielded from short-term politics can make unpopular choices, such as raising rates before an election, and that countries with independent central banks have tended to have lower inflation. Critics on both left and right argue that an unelected body making decisions with such large effects should answer more directly to voters, or that it has stretched its role in crises. The Fed reports to Congress and its chair testifies twice a year, but Congress doesn't fund it through yearly appropriations; it pays its costs from the interest on its holdings.

Why does the Fed matter to everyday life?

Its decisions reach almost everyone: the rate on a car loan, what a savings account pays, how easy it is to find a job, how fast prices rise at the store. They also reach far beyond the United States, because so much of the world's trade and borrowing is in dollars, as the note on why the dollar is the reserve currency explains. When it raises rates too far or too fast, it can help tip the economy into a recession; when it keeps them too low for too long, inflation can take hold. Understanding the Fed is a large part of understanding economics as it plays out in the news.

Check yourself

• Name the Fed's three parts and say what each one does.
• What does the dual mandate ask for, and why does the Fed aim for 2% inflation rather than zero?
• Trace how a rise in the Fed's target rate reaches the interest on a credit card.

Sources

• Federal Reserve Act signed by President Wilson — Federal Reserve History
• Federal Open Market Committee — Board of Governors of the Federal Reserve System
• Board members — Board of Governors of the Federal Reserve System
• Why does the Federal Reserve aim for inflation of 2 percent over the longer run? — Board of Governors of the Federal Reserve System, 2025
• Policy tools — Board of Governors of the Federal Reserve System
• The Federal Reserve's dual mandate — Federal Reserve Bank of Chicago