What Is the Federal Reserve?
The Federal Reserve, often called the Fed, is the central bank of the United States, created by Congress in 1913. It consists of a Board of Governors in Washington, D.C., twelve regional Reserve Banks, and the Federal Open Market Committee (FOMC), which makes interest rate decisions.
Congress gave the Fed a dual mandate: promote maximum employment and keep prices stable, which the Fed interprets as roughly 2% inflation over time. Unlike fiscal policy, the Fed operates independently of the White House, though its chair is nominated by the president and confirmed by the Senate.
How the Fed Sets Policy
The FOMC meets eight times a year to set a target range for the federal funds rate, the overnight rate banks charge each other. Raising the target makes borrowing more expensive across the economy to cool inflation; cutting it stimulates spending and hiring when the economy weakens.
Beyond rates, the Fed can expand or shrink its balance sheet by buying or selling securities, a tool known as quantitative easing or tightening. It also supervises major banks, acts as lender of last resort during crises, and operates core payment systems.
Example
In response to the inflation surge that followed the pandemic, the Fed raised its policy rate from near 0% to above 5% between March 2022 and mid-2023, one of the fastest tightening cycles in decades. Mortgage rates roughly doubled, deal activity slowed, and high-growth stock valuations compressed as discount rates rose.
Why It Matters
No institution moves markets more reliably than the Fed. Every FOMC statement, press conference, and dot plot is parsed by traders because expected rate paths feed directly into bond yields, currency levels, and equity multiples.
For finance professionals, understanding the Fed is table stakes: credit costs in an LBO, the risk-free rate in a DCF, and the demand backdrop for nearly every business all trace back to Fed policy.
