US economics & the Federal Reserve
FSOT job-knowledge primer on US economic fundamentals, fiscal versus monetary policy, and the structure and tools of the Federal Reserve System.
The Federal Reserve System: structure
The Federal Reserve was created by the Federal Reserve Act of 1913, signed by Woodrow Wilson, after the Panic of 1907 exposed the absence of a lender of last resort. It is a hybrid public-private institution with three core components.
First, the Board of Governors in Washington, D.C., is a federal agency of seven members nominated by the President and confirmed by the Senate to staggered 14-year terms; the Chair and Vice Chair serve renewable four-year terms. Jerome Powell has chaired the Board since February 2018, reappointed in 2022. The long terms insulate monetary policy from electoral pressure.
Second, twelve regional Federal Reserve Banks (New York, Chicago, San Francisco, Boston, Philadelphia, Cleveland, Richmond, Atlanta, St. Louis, Minneapolis, Kansas City, Dallas) carry out operations, supervise member banks, and distribute currency. The New York Fed is first among equals because it conducts open-market operations.
Third, the Federal Open Market Committee (FOMC) sets monetary policy. It has twelve voting members: the seven governors, the New York Fed president (permanent vote), and four other reserve-bank presidents who rotate annually. The FOMC meets eight times a year.
The dual mandate and the tools
The Federal Reserve Reform Act of 1977 gives the Fed a dual mandate: maximum employment and stable prices (it added a third statutory goal, moderate long-term interest rates). Since 2012 the Fed has targeted 2 percent inflation measured by the personal consumption expenditures (PCE) price index.
The Fed's principal instruments:
- Open-market operations — buying or selling Treasury securities to move the federal funds rate, the overnight interbank lending rate. This is the day-to-day tool.
- The discount rate — the rate charged to banks borrowing directly from the Fed's discount window.
- Reserve requirements — reduced to zero in March 2020, so this tool is now dormant.
- Interest on reserve balances (IORB) and the overnight reverse repo facility — the post-2008 tools used to steer rates in an "ample reserves" regime.
- Quantitative easing (QE) — large-scale asset purchases, first deployed in 2008–09 and again in 2020, that expand the Fed's balance sheet to ease financial conditions when rates are near zero.
The Fed also acts as lender of last resort under Section 13(3) emergency authority, used in 2008 (Bear Stearns, AIG) and in March 2020 to backstop credit markets during the COVID-19 shock.
Candidates must distinguish the Fed (monetary policy, an independent central bank) from the Treasury Department (fiscal agent that issues debt and collects revenue) and from Congress, which controls taxing and spending. The 2022–23 tightening cycle—raising the funds rate from near zero to a 5.25–5.50 percent range to fight the highest inflation since 1981—is the highest-yield recent instance to retain.