Money in the U.S. Economy

While the budget remained enormously important, the job of managing the overall economy shifted substantially from fiscal policy to monetary policy during the later years of the 20th century. Monetary policy is the province of the Federal Reserve System, an independent U.S. government agency. "The Fed," as it is commonly known, includes 12 regional Federal Reserve Banks and 25 Federal Reserve Bank branches. All nationally chartered commercial banks are required by law to be members of the Federal Reserve System; membership is optional for state-chartered banks . In general, a bank that is a member of the Federal Reserve System uses the Reserve Bank in its region in the same way that a person uses a bank in his or her community.

The Federal Reserve Board of Governors administers the Federal Reserve System. It has seven members, who are appointed by the president to serve overlapping 14-year terms. Its most important monetary policy decisions are made by the Federal Open Market Committee (FOMC), which consists of the seven governors, the president of the Federal Reserve Bank of New York, and presidents of four other Federal Reserve banks who serve on a rotating basis. Although the Federal Reserve System periodically must report on its actions to Congress, the governors are, by law, independent from Congress and the president. Reinforcing this independence, the Fed conducts its most important policy discussions in private and often discloses them only after a period of time has passed. It also raises all of its own operating expenses from investment income and fees for its own services.

The Federal Reserve has three main tools for maintaining control over the supply of money and credit in the economy. The most important is known as open market operations, or the buying and selling of government securities. To increase the supply of money, the Federal Reserve buys government securities from banks , other businesses, or individuals, paying for them with a check (a new source of money that it prints) ; when the Fed's checks are deposited in banks , they create new reserves -- a portion of which banks can lend or invest, thereby increasing the amount of money in circulation. On the other hand, if the Fed wishes to reduce the money supply, it sells government securities to banks , collecting reserves from them. Because they have lower reserves, banks must reduce their lending, and the money supply drops accordingly.

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Next Article: Bank Reserves and the Discount Rate

This article is adapted from the book "Outline of the U.S. Economy" by Conte and Carr and has been adapted with permission from the U.S. Department of State.