The Great Federal Reserve | Cash Course: Economics | PragerU Kids

Before we start this episode, here's a quick preview of what's coming. Ready to take charge of your finances and master the art of money management? Cash Course is your ultimate guide to financial literacy, from personal budgeting to macroeconomics. Check out more episodes at PragerU.com. Okay, Lawrence, this is the last question. Lawrence? Lawrence? Are you listening to me? Lawrence? The dame was talking, but my mind was on a track of its own. Sir Detective, give it to me straight. Is the Fed necessary? Her question seems simple. It was anything but. I'm the curious type, so naturally, I wanted to find out who this Fed character was. Turns out, the Fed she's talking about is the Federal Reserve, our country's central bank. It's given the special status and responsibility to alter the money supply through monetary policy and to regulate the nation's banks. But how did it start? Was it 1791, the first central bank of the United States under Alexander Hamilton? Or 1816, the second central bank of the United States? As I pondered this, the dame strolled in and threw me a bone. Start with the Panic of 1907. Ah, of course, the Knickerbocker Crisis. That was a dark year, a tough year. Reckless speculation in materials like copper, as well as economic instability and weaknesses in the banking system, caused too many people to take their money out of the banks at one time, forcing many to close. This unfortunate turn of events led to the establishment of the Federal Reserve System in 1913. To assure investors about the safety of their deposits, the Fed was created to reform the American banking system and reduce the occurrence of financial panics. At least that's the story. That answers the how, but not the who. So I had Big Joe from Yonkers do some digging. As usual, Big Joe came through. The Fed is composed of three main entities, the Board of Governors, the 12 Federal Reserve Banks, and the Federal Open Market Committee. The Board of Governors is made up of seven members nominated by the president. Each member serves a maximum of 14 years, and the board reports to Congress. The Federal Reserve System itself is divided into 12 regional banks, each operated by a president and serving its specific region. These banks are located throughout the country, including branches in Boston, St. Louis, Kansas City, and San Francisco. The Federal Open Market Committee, FOMC, is a committee that makes decisions regarding monetary policy. The FOMC is made up of the members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining 11 presidents, each serving one-year terms on a rotating basis. This structure is designed to balance the monetary policy between the board in Washington and various regional banks. There was nothing there to answer the dame's question, and I let her know, but she kept putting the squeeze on me like she was making lemonade. But what does the Fed actually do? The question was obvious, but the answer? Still a mystery. So like a bloodhound on the trail, I kept hunting. That's when things started to fall into place. As I looked into it, three things seemed to stand out, like three blind mice in a maze. The Federal Funds Rate, the Reserve Requirement, and Open Market Operations. First, the Federal Funds Rate is the interest rate at which banks lend to other banks. This rate influences the broader economy by affecting borrowing costs for consumers and businesses. When the Fed raises the rate, borrowing becomes more expensive, slowing economic activity. When it lowers the rate, borrowing becomes cheaper, stimulating growth and investment. The Federal Funds Rate impacts other interest rates, like those on mortgages, credit cards, and savings accounts. But how does the Fed affect the rate? That's where the second thing comes in, the Reserve Requirement. This is the percentage of the bank's total funds that must be held in reserve at the Fed. This is to make sure that banks can meet their obligations in case of sudden withdrawals. The higher the requirement, the less money the banks can lend out, reducing the flow of money and increasing interest rates. The lower the requirement, the more money banks can lend out, increasing the flow of money and decreasing interest rates. Lastly, open market operations are actions by the Fed to buy or sell U.S. government securities, like treasury bonds, in the open market. When the Fed buys securities, it increases the money in the banking system, which leads to lower interest rates, stimulating economic activity. On the flip side, selling securities reduces the money supply and raises interest rates, discouraging economic activity. Snap out of it, Lawrence. What's the answer? Is the Fed necessary? Well, the more I thought about it, I realized that we were stumbling down the wrong alley. Whether we like it or not, like a broken heart, the Fed is here to stay. The better question is, is the Fed effective? I can almost hear the dame in my head. Well, is it? If there's one thing I've learned, the truth ain't pretty. The effectiveness of the Federal Reserve is a long-debated topic. On one hand, it can affect the money supply to try to manage inflation and stabilize prices in the economy, encouraging economic growth and employment. On the other hand, it can distort markets by monkeying with the money supply too much and causing economic mayhem. Just as I suspected, the evidence is clear as mud. The dame's not going to like this. Never mind. I'll just look it up online. I knew she was trouble the moment she walked in.