How Do Federal Reserve Banks Get Funded?
The Federal Reserve, the country’s central bank, is self-funded: It mostly gets its operations covered via interest from securities that it owns as part of the Fed’s open market operations (OMO).
That said, the funding goes towards making sure these banks do their important work. This includes making sure the U.S. economy runs smoothly and serves the public interest. The Fed also manages short-term interest rates, which in turn affects the availability of credit and eventually things like consumer spending, investment, employment, and inflation.
The bank’s goals with these actions is to promote maximum employment, keep prices stable, and keep long-term interest rates moderate.
Who Owns the Federal Reserve Bank?
Even though parts of the Federal Reserve are structured like a private bank, the Fed is not owned by anyone. Congress created the Federal Reserve in 1913, and it remains an independent government agency. However, the board that oversees it — which is appointed by the president and confirmed by the Senate — still reports to Congress today.
Its leaders are required to testify in Congress and submit a lengthy report on its plans twice a year. The Federal Reserve actually consists of 12 Reserve Banks spread across different regions of the U.S. Although each one has a board of directors and is incorporated, it’s not actually a private entity and the banks aren’t in business to make a profit.
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How Does the Federal Reserve Make Money?
The Federal Reserve does not “make” money exactly, in that it doesn’t print money — that’s the Treasury Department’s job. But it does serve as a bank for other banks and government agencies, allowing them to open accounts to hold their reserves, take out loans, issue government securities, and take other actions.
When it comes to other banks, the Fed is there to lend to them in case they have problems getting funding, either because of unexpected fluctuations in their loans and deposits or due to extreme events, such as the COVID-19 crisis.
The Fed lends at a higher rate than the market in order to ensure that it’s used as a last resort. The Federal Reserve does not lend money or provide bank accounts for individuals, as retail banks do.
In other words, your checking and savings accounts won’t be held at a Federal Reserve Bank.
While the Federal Reserve does not actually print money, it does put in orders with the U.S. Treasury for “Federal Reserve notes” based on the demand it expects both domestically and internationally.
Here’s more detail on how the Fed works and keeps our economy humming along.
Fractional Reserve Banking and the Money Multiplier
Fractional reserve banking describes the system in which only a fraction of the money on deposit is actually held as cash and available for withdrawals by customers. Here are a few aspects of this system to note:
• The Federal Reserve wants to ensure that banks keep enough money on hand so that when customers come in seeking cash, they aren’t turned away. To accomplish this, the Fed sets a reserve requirement (often 10% of all deposits) that banks must keep available. In response to the COVID-19 pandemic, this was lowered to 0% in an effort to stimulate the economy.
• The Fed buys treasuries to help create monetary reserves. It sends the funds to banks so they can make loans with it, up to that reserve requirement limit mentioned above.
• Another aspect of fractional reserve banking is what is known as the money multiplier. Financial analysts use a money multiplier equation to calculate the impact of the funds kept on reserve on the economy in general. It estimates how much money is created in the economy by the reserve system.
Here’s how the calculation looks: The amount on deposit is multiplied by one divided by the reserve requirement. So if a bank had $100 million on deposit, you would multiply that by one divided by 10% to get $1 billion. That $1 billion represents money potentially created by lending out the 90% not kept on reserve at the bank.
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The Credit Market Funnel
Another way of looking at the Federal Reserve’s role in our nation’s economy is the credit market funnel, meaning that the Fed funnels funds to businesses to grow the economy. Say the U.S. Treasury printed $20 billion in new bills, and the Fed credited $80 billion in liquid accounts. You might think the American economy got an infusion of $100 billion. But it’s actually much more than that. Credit markets act as a funnel in terms of distributing funds. As new loans are issued, more money is created. That $100 billion could trigger a tenfold monetary increase to $1 trillion.
Determining the Money Supply
Here’s another facet of what the Federal Reserve does: It considers whether our country’s money supply should be boosted. This can impact the state of the American economy. A larger money supply can lower interest rates and get more cash to consumers, which typically stimulates spending. If the Fed does feel that the money supply needs to be increased, it will typically augment bank reserves. It might purchase Treasury bonds and distribute those to banks’ reserve funds. The banks can then use some of those funds for loans and other activities.
Money Creation Mechanism
As you’ve learned, the Federal Reserve plays a vital role in determining how and when to influence the money supply in the U.S. economy. It often boils down to the Fed buying securities and putting them in the reserves of commercial banks. Those banks can then augment the amount of money in circulation by lending funds to both businesses and consumers.
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How Is the Federal Reserve Funded?
So where does the Fed get its money? Unlike other government agencies, the Federal Reserve doesn’t get its money from Congress as part of the usual budget process.
Instead, Federal Reserve funding comes mainly through interest on government securities that it bought on the open market.
These primarily include U.S. Treasury securities, mortgage-backed securities, and government-sponsored enterprise (GSE) securities.
How much money does the Federal Reserve have? As of May 2024, the Fed had nearly $7.4 trillion in assets on its balance sheet. Those have grown significantly compared to 2007 (before the financial crisis hit), when the Fed had just around $870 billion in assets.
The reason for this has to do with the Fed’s response to the Great Recession and the COVID-19 crisis, among other factors. But remember how the Federal Reserve isn’t in it for the profit? Once it pays its own overhead, the rest of its earnings go right into the country’s coffers in the U.S. Treasury.
How the Fed Affects Interest Rates
In its attempts to steer the ship of the U.S. economy on a solid course, one of the main things the Fed does is influence interest rates. The Fed can either raise or lower the federal funds rate, which is the rate at which financial institutions that hold deposits can borrow and lend funds they keep at Federal Reserve banks from each other.
The Federal Open Market Committee, which is made up of some members of the Fed’s Board of Governors and others, meets multiple times a year to determine what they want the federal fund rates to be.
These decisions then influence other longer-term interest rates, such as those on savings accounts, mortgages, and loans.
The Fed often cuts interest rates to energize the economy by making it less expensive for businesses and consumers to borrow money. It raises rates when inflation seems too high, as was the case a couple of years ago.
The rate had been cut to the 0.00% to 0.25% rate in March of 2020 due to the emergence of the COVID-19 pandemic and its expected economic impacts. However, by September of 2022, with inflation surging to 40-year highs, the rate was raised to the 3.00% to 3.25% range. As of July 2024, the Fed’s interest rate is 5.25% to 5.50%, which is far below its peak of 20% in December 1980, when the Fed was reacting to runaway inflation.
The Takeaway
Understanding the role of the Federal Reserve in our economy and how it is funded can help explain how the Fed balances our money reserves, controls inflation, and stimulates the economy’s growth. Especially in the current economic climate, knowing how the Federal Reserve works can enhance your financial literacy. This in turn can help you better manage your own money.
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FAQ
How does the Federal Reserve obtain money?
The Fed makes money mainly through interest on government securities — such as U.S. Treasury securities, mortgage-backed securities, and government-sponsored enterprise (GSE) securities — that it bought on the open market.
Who gives money to the Federal Reserve?
The Federal Reserve isn’t given money; it finances its operations via the interest made on the securities it owns.
Is the Federal Reserve self-funded?
Yes, the Federal Reserve is self-funded. It doesn’t get money via Congress but through the interest earned on the government securities that it buys.
Does the Federal Reserve print money out of thin air?
While the Federal Reserve has the power to print money, there’s a delicate balance at work. If the Fed just ordered the Treasury Department’s Bureau of Engraving and Printing to print more money without a commensurate increase in economic activity, it could trigger inflationary growth, which isn’t desirable.
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