Introduction
The Federal Reserve System, also referred to as the Fed or Federal Reserve, is the central bank of the United States of America. It was formed in 1913 following the enactment of the “Federal Reserve Act”, which passed after a series of financial crises, especially the panic of 1907 (West, 2019). As a result, there was a need to establish a central system for controlling the money, which would help alleviate the country’s effects of such financial crises (West, 2019). In this regard, the paper examines the responsibilities, functions, and operational mechanisms of the Federal Reserve System and analyzes how its policies affect the capital markets.
Role and Functions of the Federal Reserve System
The Federal Reserve formulates monetary policy to promote full employment and maintain price stability in the economy. It achieves this by managing temporary interest rates and affecting the economy’s availability and the cost of credit (“Federal Reserve Board,” 2022). Financial policies have a direct impact on stock prices, currency exchange rates, and wealth. The Fed can influence the inflation rate, employment, production, investment, and expenditure through these channels. Therefore, efficient financial policy is crucial in helping to improve employment status and stabilize prices, thereby supporting economic growth.
The Fed stabilizes the monetary system and creates mechanisms for containing certain risks through active monitoring and engagement in the U.S. and other foreign countries. It monitors risks affecting financial systems and intervenes both abroad and at home to ensure that it supports a healthy economy for businesses, households, and communities (“Federal Reserve Board,” 2022). When pursuing continued financial stability, the Fed monitors the potential buildup of risks to financial stability and uses this analysis to inform its responses. As a result, the Fed is in a position to stabilize monetary systems.
The Fed enhances the safety and trustworthiness of individual financial organizations and monitors their influence on the entire financial system. The microprudential approach ensures that individual financial systems are safe and sound (“Federal Reserve Board,” 2018). The process involves conducting a deep examination and inspection of the structure, operations, and compliance of individual institutions under the regulation of the Fed.
The main focus of this approach is on the resilience and soundness of the whole financial system. It examines how the actions of one organization impact other institutions and the broader financial system (“Federal Reserve Board,” 2018). Therefore, through this technique, the Fed can promote the safety and trustworthiness of other individual financial institutions.
The Fed promotes the payment and effectiveness of settlement systems through the services of the banking industry. Whether one pays for a babysitter in cash, receives a paycheck by direct deposit, or swipes a debit card at a grocery store, they are participating in a system of payment (“Federal Reserve Board,” 2018). Systems created to facilitate payments are vital in helping people perform financial transactions, such as when individuals or institutions purchase goods and services.
The Fed ensures the integrity of payment systems and maintains reliable movement of electronic transactions, checks, and cash throughout the market. For instance, the Federal Reserve Board in Washington, D.C., issues paper currency, which is put into circulation by Federal Reserve Banks nationwide (“Federal Reserve Board,” 2022). Through this method, the Fed can ensure there is an effective payment method.
Finally, the Fed advocates for the protection of consumers and the development of the community. The Federal Reserve ensures that consumers are protected and the community is developed through fair and transparent financial services that benefit all Americans (Bordo & Sinha, 2022). The Fed acknowledges that serving consumers well and creating a healthy community are vital in supporting and driving economic growth (Bordo & Sinha, 2022). TheFed achieves this through its work on banking regulations and supervision, community-focused research and analysis, and regular communication with the communities that the twelve Federal Reserve Banks serve.
Operational Mechanics of the Federal Reserve System
The Fed system comprises three main bodies: the Federal Open Market Committee (FOMC), the Federal Reserve Banks, and the Board of Governors. As a part of the federal government, the Board of Governors is directly answerable to Congress, guides the system, and oversees the 12 Reserve Banks (“Board of Governors,” 2022). Although the Federal Reserve frequently communicates with Congress officials and the executive branch, it follows an independent decision-making process. In this regard, the Fed’s primary daily duties comprise carrying out national monetary policy, supervising and regulating banks, maintaining financial stability, and providing banking services.
Potential for the Federal Reserve’s Monetary Policies to Impact Capital Markets
The Fed’s financial policy can have a direct or indirect impact on capital markets. On the one hand, the direct impact can be through the direction and the level of interest rates (Zhang et al., 2020). On the other hand, the indirect effect can be seen in the prospects of where inflation will head. Generally, stock markets tend to rise when the Federal Reserve lowers interest rates (Zhang et al., 2020). On the contrary, when interest rates rise, stock markets decline. Nonetheless, there is no guarantee of how the market will respond to changes in any interest rates.
Conclusion
Conclusively, the paper has examined the role, functions, and operational methods of the Federal Reserve System and explored ways in which its policies affect the capital market. For instance, one function of the Fed that has been discussed is the creation of monetary policy to enhance maximum employment and stabilize prices in the market. Therefore, it is evident from this paper that the Federal Reserve System plays a vital role in controlling the flow of money, which would help save the country in the event of a financial crisis.
References
Board of Governors of the Federal Reserve System. (2022). Financial stability. Web.
Bordo, M. D., & Sinha, A. (2022). The 1932 Federal Reserve open‐market purchases as a precedent for quantitative easing. Journal of Money, Credit, and Banking. Web.
Federal Reserve Board. (2018). Fed functions payment systems transcript – Federal Reserve. Web.
Federal Reserve Board (2022). The Fed Explained. Web.
West, R. C. (2019). Banking reform and the Federal Reserve, 1863-1923. Cornell University Press.
Zhang, D., Guo, Y., Wang, Z., & Chen, Y. (2020). The impact of US monetary policy on Chinese enterprises’ R&D investment. Finance Research Letters, 35, 101301. Web.