The Fed: Its History, Function, and Tools
Understanding the Fed: What It Is, Why It Matters, and How It Impacts Your Finances
The Fed is raising interest rates. If you’ve been following the news, you’ve likely heard it ad nauseam over the past couple of months.
The Fed.
The name conjures up images of some faceless Big Brother figure a la 1984, or a mid-century Americana Uncle Sam poster.
But what exactly is the Fed?
In this post, we’re diving into the history of the Fed — when and why it began, what it does, and the tools it uses to direct the largest economy in the world.
What is the Fed?
The Federal Reserve — or “the Fed” — is the central bank of the United States. It’s a government institution, but also one of the most independent bodies in the country.
Its main functions include:
Creating monetary policies to promote employment, stabilize prices, and moderate interest rates
Stabilizing the country’s financial system
Managing the money supply
Regulating financial institutions
Researching and analyzing consumer trends
Acting as a lender of last resort during economic crises — bailouts, stimulus, etc.
Today, the U.S. central banking system is arguably the most powerful economic institution in the world.
Why Was the Fed Created?
In the olden days, banking was decentralized. Individual banks operated — and failed — independently.
Every so often, a banking panic would grip the country, triggering widespread bank runs and collapses.
During the Panic of 1907, panic runs devastated the economy, pushing the call for reform into overdrive.
By 1913, Congress created the Federal Reserve System, whose task would be to manage the money supply, provide stability, and avoid the types of banking panics common during the Gilded Age.
Today, the Fed’s two primary mandates remain:
Price stability (moderate inflation)
Maximum sustainable employment
How Does the Fed Influence the Economy?
The Fed has several powerful tools to regulate the economy:
1. Interest Rates
The federal funds rate is the interest rate banks charge each other for overnight loans.
Raising the rate discourages borrowing and cools off inflation. Lowering it does the opposite, stimulating economic activity.
This is the main tool the Fed uses today when it adjusts interest rates in response to economic conditions.
2. Open Market Operations (OMO)
Through Open Market Operations, the Fed buys or sells Treasury securities:
Buying bonds increases the money supply and encourages lending.
Selling bonds decreases the money supply and slows inflation.
OMO gives the Fed real-time control over liquidity in the market.
3. Reserve Requirements
Banks are required to keep a certain amount of cash available, called the reserve requirement.
Learn more about required reserves here.
By lowering the reserve requirement (currently 0%), the Fed encourages more lending. By raising it, they restrict lending.
Why This Matters to NESTers
At NEST, education is one of our pillars.
Understanding the role the Fed plays — not just in headlines, but behind the scenes — helps you make smarter decisions about your finances, investments, and even career planning.
The Fed’s monetary policy actions ripple outward, influencing interest rates, inflation, unemployment, and investment returns.
Knowing what’s happening at the macro level helps Sean actively manage NEST portfolios responsively — not reactively.
Want to Learn More?
If you’d like to dig deeper into how Fed actions affect the economy and your personal investments, check out:
June’s NEST Edge Newsletter on inflation and Fed responses
At NEST, we spend hours every day analyzing financial data to stay ahead of macro trends.
We don't wait to react. We plan to thrive.
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DISCLAIMER:
We are legally obligated to remind you that the information and opinions shared in this article are for educational purposes only and are not financial planning or investment advice. For guidance about your unique goals, drop us a line at info@nestfinancial.net.