With all this talk about the “Fed lowering interest rates,” you may wonder, “Who are these guys”? What exactly is the Federal Reserve, and why does it have so much influence over my mortgage rate? Let’s break it down.
The Federal Reserve (sometimes called “The Fed”) is the U.S. central bank (which is actually a collection of 12 banks across the nation). Central banks play a major role in nearly every country’s economy, but they aren’t like the everyday banks where you deposit money or take out loans. Instead, central banks oversee and manage the entire financial system of a country or, occasionally, a group of countries.
What Does a Central Bank Do?
While individual central bank responsibilities differ by nation, most central banks exist to regulate currency and keep inflation in check. Without them, economies would lack stability. Here are some common ways central banks keep our economies afloat:
1. Control the Money Supply
One of the main jobs of a central bank is controlling the money supply (a.k.a., how much money is in circulation). They can do this by printing more money or taking some out of circulation. Many economists (but not all) believe that printing more money causes inflation. This is because, with an abundance of money circulating within the economy, economic growth is more likely to occur at the risk of price destabilization.
2. Set Interest Rates
Central banks also set key interest rates, which influence how much it costs to borrow money. If a central bank raises interest rates, it becomes more expensive to take out loans. This usually slows down spending, which can help reduce inflation. Lowering interest rates has the opposite effect.
3. Regulate Financial Institutions
Central banks also make sure that commercial banks and credit unions (the ones you do actually visit) are operating in a safe and stable way. They monitor financial institutions to ensure they have enough money in reserve to meet their obligations and don’t take too many risks.
4. Act as the Government’s Bank
Central banks often serve as the bank for the government. This means they handle the government’s funds, manage national debt, and even issue government bonds, which are a way for the government to borrow money from the public.
5. Lender of Last Resort
During financial crises, central banks can lend money to struggling banks to prevent them from going out of business. This is called being a “lender of last resort.” It helps prevent a financial collapse that could hurt the whole economy.
Major Central Banks
The top five central banks (by total assets) are run by the United States, Japan, China, Germany, and France. However, while the Bank of France (BOF) and Deutsche Bundesbank are independent central banks of their respective countries, they do not control their own currency or set independent monetary policies. Instead, they cooperate with the European Central Bank (ECB) and other Eurosystem central banks.
- The Federal Reserve (United States): Commonly known as the Fed, the Federal Reserve is the central bank of the United States. It was created in 1913 to help stabilize the U.S. economy and manage inflation and unemployment. The Federal Reserve has 12 operating arms (known as Reserve Banks) around the country. Each reserve bank operates within its open geographic area or district.
- European Central Bank (Europe): The European Central Bank (ECB) is the central component of the Eurosystem, a collective of European states. The ECB manages the euro and is responsible for monetary policy across the Eurozone, which includes Austria, Belgium, Croatia, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.
- Bank of England (United Kingdom): The Bank of England (BOE) is a publicly owned central bank that served as the model for most modern central banks. It was established in 1694 to maintain the stability of the U.K.’s financial systems.
- Bank of Japan (Japan): The Bank of Japan (BOJ) was established in 1882. It focuses on price stability and economic growth in Japan. Like other central banks, it adjusts interest rates and controls the country’s money supply.
- Swiss National Bank (Switzerland): The Swiss National Bank (SNB) was established in 1809. It has two offices—one in Berne and another in Zurich. It is responsible for Swiss monetary policy and is the sole issuer of the Swiss franc banknotes.
- People’s Bank of China (China): The People’s Bank of China (PBC or PBoC), which was established in 1948, is the central bank for the People’s Republic of China. It is responsible for overseeing the nation’s financial stability and carrying out monetary policy. The PBC influences interest rates and inflation while regulating China’s financial institutions—including commercial banks.
- Bank of Canada (Canada): The Bank of Canada (BOC) is Canada’s central bank. It is charged with ensuring the stability of the financial system in the Great White North. The BOC sets interest rates, issues monetary policy, and regulates credit and currency. The BOC is the sole issuing authority for Canadian banknotes but does not issue coins. Those are the responsibility of the Royal Canadian Mint.
- Reserve Bank of Australia (Australia): Australia’s central bank (RBA) was established in 1959 to regulate the Australian dollar, ensure stable employment rates, and promote economic prosperity for the Australian people.
Why Are Central Banks So Important?
Central banks exist to keep our economies robust and manage the value of currencies. When functioning well, they predict and prevent the kind of financial crises that could threaten a nation’s well-being. In times of crisis (like the 2008 financial meltdown or the COVID-19 pandemic), central banks play a key role in stabilizing economies by adjusting interest rates and lending money to keep businesses and financial institutions afloat.
On a macro level, central banks—especially those in major economies—influence and inform each other on monetary policy, financial stability, and other key issues. Of course, on a micro level, they aim to control inflation, but in doing so, often influence global price stability. Case in point: it is not uncommon for the policies of major central banks (like the Fed and the ECB) to affect exchange rates, commodity prices, and global inflation.
Knowing this, central banks often work together to promote sound central banking practices. This cooperation helps address systemic risks, prevent financial crises, and helps develop worldwide financial stability. So, while central banks may seem like behind-the-scenes players, they affect your daily life in very real ways, from the interest rate on your credit card to the prices you pay for everyday goods.
Want to learn more about the history and fundamentals of banking?
- Check out our article on how to kickstart your savings for National Savings Day.
- Learn how Maps Credit Union got its start—almost 90 years ago.
- Discover the stories behind popular money superstitions like lucky pennies and itchy palms.