Federal Reserve System Law and Legal Definition

On December 23, 1913, the Federal Reserve System, which serves as the nation's central bank, was created by an act of Congress. The System consists of a seven member Board of Governors with headquarters in Washington, D.C., and twelve Reserve Banks located in major cities throughout the United States.

The seven members of the Board of Governors are appointed by the President and confirmed by the Senate to serve 14-year terms of office. Members may serve only one full term, but a member who has been appointed to complete an unexpired term may be reappointed to a full term. The President designates, and the Senate confirms, two members of the Board to be Chairman and Vice Chairman, for four-year terms.

The Fed can put more money in the economy - actually create money - by buying U.S. government securities on the open market. The Fed pays sellers for the securities. They, in turn, deposit the money in various financial institutions. While these financial institutions are required by law to keep a certain percentage of this money on reserve, they are free to loan out the remainder.

Another way in which the Federal Reserve can influence the economy is by raising or lowering the discount rate, the interest rate charged financial institutions when they borrow reserves from the Fed. The Federal Reserve can also have a powerful impact on the flow of money and credit by either raising or lowering reserve requirements, the percentage of their deposits that financial institutions must keep on reserve. If the Fed lowers reserve requirements, this can lead to more money being injected into the economy since it frees up funds that were previously set aside. On the other hand, if the Fed raises reserve requirements, it reduces the amount of money that institutions are free to loan out or invest. However, the Fed is cautious about changing reserve requirements and has done so only occasionally because of the dramatic impact it can have on both financial institutions and the economy.

When we pay taxes, our payments eventually go into an account at a Federal Reserve Bank. These accounts, which are much like the ones we have at financial institutions, are used by various agencies to make payments such as military payrolls and Social Security benefits. The Federal Reserve helps the Treasury by selling and redeeming Treasury securities: savings bonds as well as Treasury bills, notes, and bonds. The Federal Reserve is also responsible for supervising and regulating many financial institutions.