American Finance 101 - What the Average Joe Doesn't Know About the Federal Reserve.

If you ask the average American what they know about the Federal Reserve Bank, the answer is likely to be that they simply do not know much. What an unfortunate fact, since the Federal Reserve Bank has such a huge impact on the entire American, and by extension, world economy.

The current United States Federal Reserve banking system is not the first attempt at creating a central bank in the U.S. The first central bank was created in 1791 for the purpose of monitoring commercial banks and conducting currency transactions, and only lasted for twenty years. Its charter was not renewed due to its misuse of funds. The second central bank was created shortly after the War of 1812. It went to work attempting to fix the economic crisis of the nation by creating money and financing banks. When the central bank stopped flooding the economy with money, bankruptcies and foreclosures resulted for many borrowers. Much of the property that was purchased with the funds from the more liberal initial policies of the bank ended up back in the hands of the lenders.

What about our current central banking system? The current Federal Reserve System was created in 1913 by the enactment of the Federal Reserve Act. This Act gave the System the responsibility for setting the monetary policy of the United States. This System consists of five separate components:

• The Board of Governors - Headquartered in Washington, D.C., the Federal Reserve Board of Governors is comprised of seven members who are nominated by the U.S. President and confirmed by Senate. No two governors may be from the same Federal Reserve District. The Board of Governors is responsible for setting the discount rate and reserve requirements.

• The Federal Open Market Committee - The Federal Open Market Committee is responsible for the purchase and sale of U.S. Treasury and federal agency securities, which is known as "open market operations." This is one of the Federal Reserve's most important tools for implementing monetary policy. The Federal Open Market Committee consists of the seven members of the Board of Governors, the President of the Federal Reserve Bank of New York, and four other Reserve Bank Presidents, who serve rotating one year terms.

• Twelve regional Federal Reserve Banks - These twelve regional Federal Reserve Banks are located in major cities throughout the United States. The following cities are home to regional Federal Reserve Banks: Boston, Massachusetts; New York, New York; Philadelphia, Pennsylvania; Cleveland, Ohio; Richmond, Virginia; Atlanta, Georgia; Chicago, Illinois; St. Louis, Missouri; Minneapolis, Minnesota; Kansas City, Missouri; Dallas, Texas; and San Francisco, California. Each regional Federal Reserve Bank has its own nine-member board of directors.

• Member banks - Many privately owned U.S. banks are members of the Federal Reserve System. This means that they own stock in a regional Federal Reserve bank. This stock cannot be publicly traded like most stocks, but the member banks do receive a fixed 6% annual dividend on their stock, and have voting rights on six of the nine member of the board of directors for the Reserve Bank they which it holds stock.

• Advisory committees - There are various advisory committees that help shape the monetary policies of the Federal Reserve System. Three committees directly advise the Board of Governors. These are the Federal Advisory Council, the Consumer Advisory Council, and the Thrift Institutions Advisory Council.

The various parts of the Federal Reserve System work together to use three main tools to set the monetary policy of the United States by 1) setting the discount rate, which is rate at which banks lend money to one another, 2) controlling open market operations, and 3) implementing requirements concerning the amount of money that member banks must hold in reserve. As you can see, these actions have a huge impact on the U.S. economy by directly controlling interest rates and the amount of currency available, and indirectly shaping inflation and economic growth.