by
Charles Lamson
Over the 104 years since its inception, the Fed's powers and responsibilities have gradually expanded. In some cases, the Fed argued that it needed more powers to accomplish its existing responsibilities, or that taking on additional responsibilities was a natural adjunct to what it is already doing. Congress often responded favorably to the Fed's argument or simply let the Fed decide on its own if it would be the best agency to handle a particular set of issues. The current list of Fed responsibilities is considerably longer and more encompassing than even the most farsighted legislator could have imagined in 1913. Fortunately, the list can be divided into four functional areas, depicted in Exhibit 1, and outlined in the following text.
1. The Functions of the Fed
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Formulation and Implementation of Monetary Policy
A primary responsibility of the Federal Reserve is the formation and implementation of the nation's monetary policy. Broadly speaking, the conduct of monetary policy has two objectives: first, to ensure that sufficient money and credit are available to allow the economy to expand along its long-term potential growth trend under conditions of relatively little or no inflation; second, in the shorter run, to minimize the fluctuations---recessions or inflationary booms---around the long-term trend.
In general, the Fed takes actions to affect the cost and availability of funds in the financial system. More specifically, the Fed's actions have a direct effect on the ability of depository institutions to extend credit on the nation's money supply, and on interest rates. The Fed has a pervasive effect on the environment in the financial system and the overall health and performance of the economy. For example, by taking actions that increase the availability of funds, the Fed may bring about an expansion of the money supply and a decline in interest rates, or it can do the reverse. Its decisions may, in turn, affect the spending, producing, borrowing, lending, pricing, and hiring decisions made in the rest of the economy.
Supervision and Regulation of the Financial System
The Fed, along with several other government agencies is responsible for supervising and regulating the financial system. In general, supervisory activities are directed at promoting the safety and soundness of depository institutions. from the Fed's perspective, this involves continuous oversight to be sure that banks are operated prudently and in accordance with statutes and regulations. Operationally, this means the Fed sends out teams of bank examiners (auditors) to assess the condition of individual institutions, and to check compliance with existing regulations. On a more regular basis, banks must submit reports of their financial conditions and activities.
Facilitation of the Payments Mechanism
The payments mechanism is at the heart of the nation's financial system. Many billions of dollars are transferred each day to pay for goods and services, settle debts, and acquire securities. Since any distribution of this mechanism could prove deleterious to the economy, the Fed is committed to the development and maintenance of safe and efficient means for transferring funds---that is, making payments.
Most obviously, the Fed facilitates the transfer of funds by providing currency and coin and clearing checks. As Exhibit 2 illustrates, the Fed plays a central role in the transfer of funds initiated by the writing of a check. The task is enormous. The Fed clears millions of checks (or similar) items each business day. So you can see why the Fed has encouraged the adoption of technological advances, such as the electronic funds transfer system, which can lower the cost and speed the transfer of funds.
The arrows show the movement of a check through the system. The Fed plays two roles: (1) it forwards the check from the bank receiving the check (Dad's bank) to the bank on which it is written (Mary's); (2) it transfers funds from the bank on which the check is written (drawn) to the bank receiving the deposit (Dad's). When the process is complete, Mary has less funds in her account, and Dad has more funds in his.
Operation as Fiscal Agent for the Government
As chief banker for the U.S. government, the Fed furnishes banking services to the government in a manner similar to the way private banks furnish banking services to their customers. For example, the Fed maintains the Treasury's transactions account. government disbursements, such as funds for the purchase of a missile, are made out of this account, and payments to the government, such as taxes, are made into this account. The Fed also clears Treasury checks, issues and redeems government securities, and provides other financial services. It acts as the fiscal agent of the government in the financial transactions with foreign governments and foreign central banks.
Recap
The major responsibilities of the Fed include setting monetary policy, regulating and supervising the financial system, facilitating the payments mechanism, and acting as fiscal agent for the U.S. government.
*SOURCE: THE FINANCIAL SYSTEM & THE ECONOMY 3RD ED., 2003, MAUREEN BURTON & RAY LOMBRA, PGS. 87-90*
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