What the Federal Reserve Actually Does

In November 1910, six men boarded a private rail car at a small station in Hoboken, New Jersey, with instructions to use only first names and to tell no one where they were going. The destination was the Jekyll Island Club, a private hunting resort off the coast of Georgia owned by a group that included J.P. Morgan and William Rockefeller. The travelers included Senator Nelson Aldrich, the chair of the National Monetary Commission; Paul Warburg, a German-born partner at Kuhn, Loeb & Co. and the meeting's principal economic mind; Frank Vanderlip of National City Bank; Henry Davison of J.P. Morgan; Charles Norton of First National Bank of New York; and Treasury Assistant Secretary A. Piatt Andrew. Over ten days they drafted what became the Aldrich Plan — a proposal for a privately-controlled central reserve association — which, after three years of revision, redrafting, and Democratic political surgery, became the Federal Reserve Act, signed into law by Woodrow Wilson on December 23, 1913. The trigger for the entire effort had been the Panic of 1907, in which J.P. Morgan personally rescued the U.S. financial system by locking the heads of the major New York banks in his library and refusing to let them out until they agreed on a plan.

The structure that resulted is a deliberately federalist hybrid that defies the standard categories. At the top sits a seven-member Board of Governors based in the Eccles Building on Constitution Avenue in Washington, appointed by the president to staggered fourteen-year terms and confirmed by the Senate. The chair, currently Jerome Powell — first appointed by Donald Trump in February 2018, reappointed by Joe Biden in 2022 — serves a separate four-year term within the longer governor term. Beneath the board sit twelve regional reserve banks: Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. Each is chartered as a private corporation whose stock is owned by the commercial banks that are members of the system in that district, but whose profits, after a fixed dividend to member banks, are remitted to the U.S. Treasury. The reserve banks supervise the commercial banks in their region, hold their reserves, and operate the payment systems through which essentially all U.S. dollar transactions ultimately clear.

Monetary policy is set by the Federal Open Market Committee, the FOMC, which meets eight times a year. It has twelve voting seats: the seven Washington governors, the president of the New York Fed permanently, and four other reserve bank presidents on a rotating annual basis. Decisions are made by majority vote and announced through a short statement and, more recently, an extensive set of economic projections known as the dot plot. The mechanism the FOMC operates is the federal funds rate target — the interest rate at which depository institutions lend reserves to one another overnight. Until 2008 the New York Fed's open market desk hit that target by buying and selling Treasury securities to add or drain reserves; since the post-2008 expansion of the Fed's balance sheet, the binding tools have been the interest paid on reserves held at the Fed and the rate offered on reverse repurchase agreements, which together form a corridor that keeps overnight market rates close to target.

The Fed's mandate, as Congress codified it in the Federal Reserve Reform Act of 1977 and the Full Employment and Balanced Growth Act of 1978 — better known by the names of its sponsors as Humphrey-Hawkins — is dual: maximum employment and stable prices, with a secondary mandate of moderate long-term interest rates. In 2012, under Ben Bernanke, the FOMC formally defined "stable prices" as 2 percent annual inflation as measured by the personal consumption expenditures price index. In August 2020, under Jerome Powell, the committee adopted a flexible average inflation targeting framework, accepting periods of above-2 percent inflation to make up for previous shortfalls below it.

The crisis years stretched the toolkit considerably. During and after the 2008 financial crisis, the Fed expanded its balance sheet from roughly $900 billion to $4.5 trillion through three rounds of quantitative easing — purchases of Treasury securities and mortgage-backed securities — and created a series of emergency lending facilities including the Term Auction Facility, the Commercial Paper Funding Facility, and the Term Asset-Backed Securities Loan Facility. Bloomberg sued the Fed under the Freedom of Information Act for the names of the firms that received emergency loans, won at the trial court, and after appeals up to the Supreme Court, forced disclosure on March 31, 2011. During the COVID-19 emergency in March 2020, the Fed reactivated several of those facilities within days and added new ones for municipal bonds and corporate credit. The balance sheet peaked above $9 trillion in 2022.

The central bank is also a financially unusual entity. The Fed earns interest on its bond portfolio and pays interest on the reserves commercial banks hold with it. For most of its history the spread was positive, and the Fed remitted its operating profits to the Treasury — about $109 billion in 2021. When the FOMC raised the federal funds rate from near zero to over 5 percent between March 2022 and July 2023 to fight post-pandemic inflation, that arithmetic flipped: the Fed posted a record net loss of $114.3 billion in 2023, the first material loss in its history, and stopped its remittances to Treasury entirely, recording the shortfall as a deferred asset to be repaid out of future surpluses.