Why Has the Federal Reserve Been in the Spotlight in the Last Year?

Since the beginning of 2022, the Federal Reserve, currently headed by Jerome Powell, has been front and center as it works to stamp out inflation. 2022 saw a year of unprecedented rate increases, which effectively threw the market into turmoil. To understand why the Fed has been such an important entity as of late, let’s step back and understand the background of The Federal Reserve.

The Federal Reserve, commonly known as “the Fed," is the central bank of the United States. It was created by Congress in 1913 to provide the nation with a stable, flexible, and safe monetary and financial system. The Fed is responsible for implementing monetary policy in the U.S., which refers to the actions it takes to influence the supply and demand of money and credit in the economy.

The Fed is independent of the government, but it is subject to oversight by Congress. It is made up of three key entities: the Board of Governors, the 12 Federal Reserve Banks, and the Federal Open Market Committee (FOMC). The Board of Governors, a seven-member board that is appointed by the President and confirmed by the Senate, is responsible for overseeing the operations of the Federal Reserve Banks and for setting monetary policy. The Federal Reserve Banks are responsible for implementing the policies set by the Board of Governors and for providing financial services to banks and other financial institutions. The FOMC, the main policy-making body of the Fed, is made up of the seven members of the Board of Governors and five of the 12 Federal Reserve Bank presidents.

One of the main responsibilities of the Fed is to regulate the supply of money and credit in the economy. It does this through a variety of tools, including setting the target federal funds rate, which is the interest rate at which banks lend to each other overnight. The Fed can also influence the money supply by buying and selling securities in the open market, a process known as open market operations. When the Fed buys securities, it adds money to the financial system, and when it sells securities, it removes money from the financial system.

What we have been seeing the Fed doing recently is selling securities. Its goal in doing that is to take money out of the hands of Americans to, hopefully, bring inflation down. This is also called Quantitative Tightening, or “QT.”

Another key responsibility of the Fed is to promote the stability of the financial system. It does this by overseeing and regulating banks and other financial institutions to ensure that they are operating safely and soundly. The Fed also serves as a "lender of last resort" to banks in times of financial stress, providing them with the funds they need to meet their obligations.

In addition to its monetary and regulatory responsibilities, the Fed also plays a key role in the U.S. payments system. It operates and maintains the infrastructure that enables the transfer of funds between banks and other financial institutions, which is critical to the smooth functioning of the economy. The Fed also works to protect consumers by implementing and enforcing regulations to prevent financial fraud and abuse.

The Fed plays a vital role in the U.S. economy. Its actions can have a significant impact on inflation, employment, and financial stability (as we have seen). While the Fed is independent of the government, it is accountable to Congress and the public, and its decisions are subject to review and oversight.

While we don’t know for sure the final impact the Fed’s decisions regarding interest rates will have on the U.S. economy, we believe they are doing their best to stamp out inflation and avoid the “stop and go” policies of the 1970s, which created nearly a decade of high interest rates and high inflation. This may result in a 2023 or 2024 recession, but history has shown that while recessions are painful, they effectively stamp out inflation.

VK2023-0112