FXstreet

The Federal Reserve Explained In 7 Minutes

Chair Janet Yellen grabbed everyone’s attention this year when she implied that the Federal Reserve, aka the Fed, may raise interest rates for the first time in six years. The markets have been responding ever since, once again proving that the Fed holds a lot of the cards when it comes to the U.S. economy.

But what exactly is the Fed? And how did it become so powerful?

Then there’s monetary policy, and that’s where the Fed comes in.

The Fed, while a government agency, is independent and operates without needing the approval of the branches of government. It was created in 1913 with the Federal Reserve Act as a way to centralize and regulate banking to avoid economic collapse. Now, as the nation’s central bank, the Fed supervises other banks to ensure they’re safe places for people to keep their money.

The Fed also studies economic trends and makes decisions intended to keep the economy healthy and employment levels high. It regulates interest rates and money availability. For example, if the Fed wants to hit the economic accelerator, the central bank will buy bonds from banks, increasing the money supply and spurring more lending to consumers and businesses.

In an economy with little growth, the Fed tries to encourage spending and hiring, so it will also lower interest rates. This means lower interest rates for the banks, which in turn means lower interest rates for customers when it comes to loans, mortgage rates, and more. When the economy’s in good shape but at risk of running too hot — meaning there’s too much inflation — the Fed does the opposite and increases the interest rates to steady things.