The Federal Reserve is the federal banking authority in the US that performs the functions of a

central bank and is used to implement the country's monetary policy, providing a national system of
reserve cash available to banks. Created in 1913, the Federal Reserve System consists of twelve
Federal Reserve Districts, each having a Federal Reserve Bank. These are controlled from
Washington, DC, by the Federal Reserve Board consisting of governors appointed by the US
president with Senate approval.

Following the Federal Reserve Act of 1913, the Federal Reserve (the U.S. central bank) was given the
authority to formulate U.S. monetary policy. To do this, the Federal Reserve uses three tools: open
market operations, the discount rate and reserve requirements.

The three instruments we mentioned above are used together to determine the demand and supply
of the money balances that depository institutions, such as commercial banks, hold at Federal
Reserve banks. The dollar amount placed with the Federal Reserve in turn changes the federal funds
rate. This is the interest rate at which banks and other depository institutions lend their Federal Bank
deposits to other depository institutions — banks will often borrow money from each other to cover
their customers' demands from one day to the next. So, the federal fund rate is essentially the
interest rate that one bank charges another for borrowing money overnight. The money loaned out
has been deposited into the Federal Reserve based on the country's monetary policy.

Open market operations are essentially the buying and selling of government-issued securities (such
as U.S. T-bills) by the Federal Reserve. It is the primary method by which monetary policy is
formulated. The short-term purpose of these operations is to obtain a preferred amount of reserves
held by the central bank and/or to alter the price of money through the federal funds rate.

When the Federal Reserve decides to buy T-bills from the market, its aim is to increase liquidity in
the market, or the supply of money, which decreases the cost of borrowing, or the interest rate and
it is opposite when it sells T-bills to the market is a signal that the interest rate will be increased
therefore increasing the demand for money and its cost of borrowing.

The discount rate is essentially the interest rate that banks and other depository institutions are
charged to borrow from the Federal Reserve. Under the federal program, qualified depository
institutions can receive credit under three different facilities: primary credit, secondary credit and
seasonal credit.

Each form of credit has its own interest rate, but the primary rate is generally referred to as the
discount rate.

 The primary rate is used for short-term loans, which are basically extended overnight to
banking and depository facilities with a solid financial reputation. This rate is usually put
above the short-term market-rate levels.
 The secondary credit rate is slightly higher than the primary rate and is extended to facilities
that have liquidity problems or severe financial crisis.
 Finally, seasonal credit is for institutions that need extra support on a seasonal basis, such as
a farmer's bank. Seasonal credit rates are established from an average of chosen market
rates.

The reserve requirement is the amount of money that a depository institution is obligated to keep in
Federal Reserve vaults, in order to cover its liabilities against customer deposits. The Board of
Governors decides the ratio of reserves that must be held against liabilities that fall under reserve
regulations. Thus, the actual dollar amount of reserves held in the vault depends on the amount of
the depository institution's liabilities.

By influencing the supply, demand and cost of money, the central bank's monetary policy affects the
state of a country's economic affairs. By using any of its three methods — open market operations,
discount rate or reserve requirements — the Federal Reserve becomes directly responsible for
prevailing interest rates and other related economic situations that affect almost every financial
aspect of our daily lives.

The Fed's principal goal of economic stability has not changed since its creation in 1913 with the
passage of the Federal Reserve Act. Its role, however, has grown a great deal. Just in the past
decade, Fed functions changed and expanded to deal with dramatic transformations in financial
institutions, payments processes and markets. n response to the financial crisis that peaked in late
2008, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act) of 2010. The Dodd-Frank Wall Street Reform and Consumer Protection Act targeted the
sectors of the financial system that were believed to have caused the 2008 financial crisis, including
banks, mortgage lenders, and credit rating agencies.