The Federal Reserve Bank and Monetary Policy in the U.S.

While attempts at central banking in the United States go back as far as the 18th and 19th century with the creation of First and Second Banks of the United States, the Federal Reserve System was not established until 1913 via the Federal Reserve Act.

The Federal Reserve Act was based on the work of the National Monetary Commission, which was charged with proposing reforms to the nation's monetary system after the Bankers' Panic of 1907. The Commission's final recommendations were driven by its chairman, Senator Nelson Aldrich. At a secret meeting on Jekyll Island, Georgia in 1910, Aldrich had devised a plan for a central banking system in collaboration with some of the country's most powerful bankers, among them Paul Warburg, a director at Wells-Fargo Co. (he would later become a member of the first Federal Reserve Board); Frank Vanderlip, president of National City Bank; Harry P. Davison, a partner at J.P. Morgan, and Benjamin Strong, vice president of Banker's Trust Co.

The Federal Reserve System comprises the Washington, D.C.-based Board of Governors, whose seven members are appointed by the President and confirmed by the Senate for 14-year terms, and 12 regional Reserve Banks.

The Board of Governors sets the discount rate and reserve requirements. The discount rate is the interest rate that banks are charged on loans made to them by their regional Federal Reserve Banks. It is also referred to as the "discount window." Reserve requirements are the amount of "reserves in the form of vault cash or deposits with Federal Reserve Banks" that banks must hold. Note that "[w]ithin limits specified by law, the Board of Governors has sole authority over changes in reserve requirements."

Additionally, all members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four other regional Federal Reserve Bank presidents form the Federal Open Market Committee (FOMC). The FOMC determines the Fed's monetary policy through open market operations--essentially the Fed's buying and selling of U.S. government securities such as Treasury bonds.

Supporters of central banking argue that by determining money supply and cost of credit in the market, the Fed can achieve its dual mandate of full employment and stable prices. The Fed is thus thought to provide a stabilizing role in the economy.

However, there is much debate over whether the Fed can and should pursue such a dual mandate in the first place, by what means, it can and most importantly, whether, on balance, its actions indeed have benefited the American economy so far. For instance, since the Fed came into existence in 1913, the U.S. Dollar has lost 95 percent of its value. Many economic historians now blame the Fed's contractionary monetary policy for the Great Depression; most recently some also contend that the Fed's manipulation of interest rates played a detrimental role in the 2008 financial crisis. Further, considerable argument exists over the opaqueness with which the Fed conducts its business.

In any event, to understand the past and current state of our economy, learning about the Fed is crucial. Hence, in this topic you will find extensive resources on the history as well as assessments of the Federal Reserve.