WASHINGTON, September 14 — The Federal Reserve System was created by the Federal Reserve Act, signed by President Woodrow Wilson on December 23, 1913, making it the central bank of the United States and the primary institution through which monetary policy is conducted. The Fed was established in response to the Panic of 1907, a severe financial crisis that exposed the fragility of the U.S. banking system without a central authority to provide liquidity.
The institution is composed of a Board of Governors in Washington, D.C., twelve regional Federal Reserve Banks, and the Federal Open Market Committee, which sets the target for the federal funds rate.
What the Fed Does
The federal funds rate is the interest rate at which depository institutions lend reserve balances to one another overnight. Changes in that rate influence borrowing costs for mortgages, credit cards, auto loans, and business investment. Congress gave the Fed a dual mandate: to promote maximum employment and stable prices, often interpreted as an inflation target of 2 percent, a formal target adopted in January 2012.
During the Great Depression, the Fed’s failure to act as a lender of last resort contributed to a wave of bank failures. The Banking Act of 1933, known as Glass-Steagall, and the Banking Act of 1935 restructured its powers.
In 1979, Paul Volcker became Fed chair and aggressively raised interest rates to combat double-digit inflation. The federal funds rate peaked near 20 percent in 1981, a move that contributed to a severe recession but ultimately tamed inflation. Under Alan Greenspan, who chaired from 1987 to 2006, the Fed navigated the 1987 stock market crash, the 1990s expansion, and the dot-com bust.
Ben Bernanke, chair from 2006 to 2014, led the Fed during the 2007-2008 global financial crisis, cutting rates to near zero and pioneering quantitative easing, large-scale asset purchases that expanded the Fed’s balance sheet from roughly $900 billion in 2007 to over $4 trillion by 2014. Janet Yellen, chair from 2014 to 2018, began the process of normalizing policy, gradually raising rates from late 2015.
Jerome Powell became chair in 2018 and initially continued rate hikes, but the COVID-19 pandemic in 2020 prompted the Fed to slash rates to a target range of 0 to 0.25 percent and launch unlimited QE, expanding its balance sheet to nearly $9 trillion by 2022.
Inflation surged to 9.1 percent in June 2022, the highest in over 40 years, leading the FOMC to raise rates eleven times between March 2022 and July 2023, bringing the federal funds rate to a target range of 5.25 to 5.5 percent, the highest in 22 years.
Global Reach and Political Independence
The Fed’s actions affect global financial conditions, as the U.S. dollar is the world’s primary reserve currency. Its decisions are closely watched by investors, businesses, and governments worldwide. Its independence from political pressure is a cornerstone of its design, though it remains subject to congressional oversight and must report to Congress twice a year.
In recent years, the Fed has also focused on climate-related financial risks and community development. The institution’s evolution reflects the changing nature of the U.S. economy and its role in the global financial system.
