The Federal Reserve: CNBC Explains

How does the Fed affect U.S. citizens?

It has a major impact on daily lives of nearly every American. As we mentioned above, the Fed can raise interest rates to slow down the economy. That means buying a home or a car can be more expensive if you have to pay more interest on a loan. Credit card interest rates can also go up.

An even greater impact could be fewer jobs as business costs to borrow money go up—those interest rates again—and firms may want to lay off people instead of hiring them.

And if the Fed cuts back on buying securities (quantitative easing) it is lowering the amount of money circulating in the economy—and creating less consumer spending.

Of course, the opposite is true. If the Fed lowers interest rates and borrowing costs, that makes a home or car purchase cheaper. And that could also mean businesses would borrow money at a cheaper rate and think about hiring if the economy picks up steam and consumers are spending.

How is the Federal Reserve System made up?

Under the Federal Reserve System, the United States is divided into 12 districts. Each district has an actual bank, called a reserve bank, serving it. But it's not the type of bank where the average citizen deposits money. Rather, it hold the funds of the Fed, which we'll describe below. 

The 12 Reserve Banks are named after the city in which they are located. Those are Boston, New York, San Francisco, Philadelphia, Cleveland, Chicago, Richmond, St. Louis, Minneapolis, Atlanta, Kansas City, and Dallas.

Each reserve bank is run by a staff headed by a president or chairman, who also help make up the very important Federal Open Market Committee.

What is the Board of Governors?

The Board of Governors oversees the Fed. It is made up of seven members who, as we mentioned above, are appointed by the President and confirmed by the Senate. The full term of a Board member is 14 years, and the appointments are staggered so that one term expires on each even-numbered year.

The board members can come from within the Fed—many Federal Reserve bank presidents have gone from the banks to the board—or they can come from academia and other places. The President can appoint anyone he believes is qualified to serve.

A Chairman and Vice Chairman lead the Board. They too, are appointed by the President and confirmed by the Senate. But the nominees to these posts must already be members of the existing board.

The terms for these two top positions are four years, but the Chairman and Vice Chairman may be reappointed for additional four-year terms—as long as their term as Board member is active.

How Has the Fed Changed Over the Years?

Various changes over the years have given the Fed more power and responsibilities. Before 1937 for example, there was no FOMC issuing economic policy statements.

In the 1940s, the Fed and the banking industry developed the routing numbers that you see at the bottom of your checks—to identify the bank and account from which the check is written. This move led to the automation of check processing.

In response to banking and other financial problems that developed in the 1980s, the Fed Board adopted a policy in 1985 requiring the Reserve Banks to inspect once a year the various holding companies of the nation's larger banks. This is to make sure the banks themselves have enough reserve funds.

In 1991, the Right to Truth in Savings Act empowered the Fed to require that banks disclose account information to consumers, including the annual percentage yield; regulated advertising of savings accounts; and prohibited certain methods of calculating interest.

As a result of the Recession of 2007-2009, the Fed will oversee the Bureau of Consumer Financial Protection (CFPB)—an independent bureau within the Fed to help give consumers the information they need to make financial decisions.