What Is the U.S. Federal Reserve?

Introduction

The U.S. central banking system—the Federal Reserve, or the Fed—is the most powerful economic institution in the United States, and perhaps the world. Its core responsibilities include setting interest rates, managing the money supply, and regulating banks and the U.S. payment system. It also acts as a lender of last resort during periods of economic crisis, as demonstrated during the 2008 financial meltdown and the COVID-19 pandemic.

Given the scope of its powers, the Fed is no stranger to controversy. Some economists argue that its aggressive policies risk fueling inflation and inflating asset bubbles, while others feel the Fed’s support for financial markets favors big business over workers. The central bank is also one of the most politically independent U.S. government bodies, which has long caused tension with lawmakers and presidents. That tension has escalated in 2025 as President Donald Trump has increasingly criticized the Fed’s spending and called for greater congressional oversight of the institution.

In August 2025, Trump attempted to fire Federal Reserve Governor Lisa Cook. The U.S. Court of Appeals temporarily blocked Cook’s removal, a decision the White House intends to appeal to the Supreme Court. Trump appointed Stephen Miran, a White House advisor, to the Federal Reserve Board in September 2025 to replace Adriana Kugler. Miran is the first person to serve on the Fed while also retaining a government position since the 1930s. This dual role has led critics to raise concerns about the central bank’s political independence. 

What does the Fed do?

For most of the nineteenth century, the United States had no central bank to serve as a lender of last resort, leaving the country vulnerable to a series of financial panics and banking runs. In response, Congress passed—and President Woodrow Wilson signed into law—the 1913 Federal Reserve Act, which created a Federal Reserve System of twelve public-private regional banks. The New York Fed, which is responsible for the heart of the nation’s financial life, has long been considered the most important of these banks. It runs the Fed’s trading desks, helps regulate Wall Street, and oversees the largest pool of assets.

Today, the Fed is tasked with managing U.S. monetary policy, regulating bank holding companies and other member banks, and monitoring systemic risk in the financial system. The seven-member Board of Governors, the system’s seat of power, is based in Washington, DC, and currently led by Fed Chair Jerome Powell. Each member is appointed by the president to a fourteen-year term, subject to confirmation by the Senate. The Board of Governors forms part of a larger board, the Federal Open Market Committee (FOMC), which includes five of the twelve regional bank presidents on a rotating basis. The FOMC is responsible for setting interest rate targets and managing the money supply. 

Historically, the Fed has been driven by a dual mandate: first, to maintain stable prices, and second, to achieve full employment. It is one of only a few central banks in the world that has a dual mandate, which Congress established through legislation in the 1970s—specifically the Federal Reserve Reform Act and the Humphrey-Hawkins Act. The Fed sets an annual inflation target of 2 percent in pursuit of price stability, and while economists debate the definition of full employment, they generally accept it to mean an unemployment rate of around 4–5 percent.

To fulfill its mandate, the Fed’s most important lever is the influence it exerts over banking reserves and short-term interest rates. A central tool in this process is the federal funds rate—the rate at which banks borrow and lend to each other overnight. While the Fed doesn’t directly set this rate, the FOMC sets a target range for it. The Fed then uses tools such as open-market operations, the interest on reserve balances, and the overnight reverse repurchase facility to guide the actual rate toward that target. By purchasing bonds, the Fed increases the amount of reserves in the banking system, helping to lower the federal funds rate and ease borrowing conditions.

What does the Fed chair do?

Few officials in Washington enjoy the power and autonomy of the Federal Reserve chair. The chair acts as the central bank’s spokesperson, negotiates with the executive branch and Congress, and controls the agenda of the board and FOMC meetings. Analysts and investors take their cues from the chair, and markets instantly react to the faintest clues on interest rate policy.

The chair is appointed by the president, and the Fed, which controls its own budget, is mostly independent from the whims of Congress. Once confirmed, the Fed chair is also largely free of control by the White House; there is no accepted mechanism for a president to remove them, and it is legally uncertain if one could do so at all.

Recent Fed chairs include:

Paul Volcker, 1979–1987. Appointed by President Jimmy Carter, Volcker was previously head of the New York Fed and took over at a time of double-digit inflation and slow growth, known as “stagflation.” To fight inflation he restricted the supply of money in the economy, pushing interest rates to their highest level in history, topping 20 percent. While the immediate result was a recession and high unemployment, many economists say this “shock therapy” set the stage for the country’s 1980s economic boom. President Ronald Reagan replaced Volcker in 1987 after disagreements over rising U.S. debt, high interest rates, and financial regulation.

Alan Greenspan, 1987–2006. Reagan appointed Greenspan, an economist and former White House advisor, who would go on to serve five terms as Fed chair under four different presidents. A noted inflation hawk and skeptic of government regulation, he was often credited with leading the U.S. economy through its long 1990s expansion. In the wake of the 2008 financial crisis, however, many experts also criticized him for doing little to regulate risky new financial products and allowing a housing bubble to build.

Ben Bernanke, 2006–2014. Appointed by President George W. Bush, Bernanke’s two terms spanned the worst years of the 2008 crisis and its aftermath, known as the Great Recession. His aggressive response included slashing interest rates to zero, supporting financial institutions on the brink of collapse, and pumping trillions of dollars into financial markets to support liquidity and lending. President Barack Obama reappointed Bernanke to a second term, crediting him with avoiding a total economic collapse.

Janet Yellen, 2014–2018. After Bernanke announced his retirement in 2013, Obama nominated Yellen, a Yale-trained economist and the first woman to head the U.S. central bank. Before becoming chair, Yellen had issued early warnings about the housing crash and pushed for more aggressive monetary policy to bring down unemployment. During her term, as the United States saw a recovery in the labor market, Yellen oversaw the first rise in interest rates in nearly a decade.

Jerome Powell, 2018–present. New presidents have almost always reappointed the sitting Fed chair to a second term, regardless of party. But after Yellen’s first term expired in February 2018, Trump replaced her with Powell, a businessman, financier, and sitting Fed governor. President Joe Biden reappointed him in 2022. Although Powell had been skeptical of some of the Fed’s regulations, he initially followed Yellen’s blueprint for slowly increasing interest rates. He has since raised interest rates to their highest level in decades to help fight inflation caused by the COVID-19 pandemic and Russia’s invasion of Ukraine. Despite initially appointing Powell, Trump in his second term has publicly criticized Powell’s rate hikes, pressuring him to cut rates to boost economic performance and reduce interest payments on government debt. The tension between Trump and Powell “risks the bank’s independence, effectiveness, and credibility,” writes Mohamed A. El-Erian, chief economic advisor at Allianz, for Foreign Affairs.

How has the Fed’s regulatory role evolved?

The Fed’s regulatory purview steadily expanded through the 1990s. The U.S. banking industry changed dramatically under a 1999 law that legalized the merger of securities, insurance, and banking institutions, and allowed banks to combine retail and investment operations. These two functions had previously been separated under the 1933 Glass-Steagall Act. The changes also made the Fed responsible for ensuring banks’ solvency by enforcing provisions such as minimum capital requirements, consumer protections, antitrust laws, and anti–money laundering policies.

The U.S. financial crisis, which expanded into a global economic crisis beginning in 2008, highlighted the systemic risk embedded in the financial system and raised questions about the Fed’s oversight. Some economists point to the repeal of Glass-Steagall in particular as the starting gun for a “race to the bottom” among financial regulators, which allowed “too-big-to-fail” institutions to take on dangerous levels of risk. As many assets became “toxic,” especially new types of securities based on risky housing loans, the federal government was forced to step in with trillions of dollars in bailout money to avert the financial system’s collapse.

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The U.S. Financial Crisis

1992-2018

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In the aftermath, debate has continued over how both regulatory changes and monetary policy created the conditions for the crisis. In addition to the Glass-Steagall repeal, regulators in the early 2000s also allowed banks to take on unprecedented levels of debt. Bernanke blamed excessive debt, lax government regulation, and gaps in oversight of too-big-to-fail banks for the disaster.

In addition, some critics blamed the Fed’s long-running policy of low interest rates for contributing to the crisis. Many economists judged Fed policy by the so-called Taylor rule, formulated by Stanford economist John Taylor, which says that interest rates should be raised when inflation or employment rates are high. Taylor and others have argued that then-Fed Chair Greenspan’s decision to keep rates low during a period of economic growth helped create the housing bubble by making home loans extremely cheap and encouraging many borrowers to go into debt beyond their means. Greenspan attributed this policy to his belief that the U.S. economy faced the risk of deflation, or a decline in prices, due to a tightening supply of credit.

How did the Fed deal with the Great Recession?

Like other central banks around the world, the Fed immediately slashed interest rates to boost lending and other economic activity. By the end of 2008, it dropped rates to near zero, where they would stay until 2015. Unlike some other central banks, such as the Bank of Japan, which implemented negative interest rates, the Fed decided against going below zero. It thought that such a move—essentially charging banks for holding their funds with the Fed in order to spur them to lend—was unlikely to have much effect.

However, the Fed did pursue another unorthodox policy, known as quantitative easing (QE), which refers to the large-scale purchase of assets, including Treasury bonds, mortgage-backed securities, and other debt. Between 2008 and 2014, the Fed’s balance sheet ballooned from about $900 billion to more than $4.5 trillion as it launched several rounds of asset buying.

The goal of QE was to further spur lending when all other monetary policy tools had been maxed out. This was thought to work in multiple ways: by taking bad assets off of banks’ balance sheets, by dramatically increasing the supply of money to be lent, and by signaling to banks and investors that the Fed was committed to taking any steps necessary to restore growth.

The move was not without its critics, as some economists feared such an increase in the money supply would cause out-of-control inflation. Many also argued that additional monetary easing would do little at a time of low demand in the economy.

Economists still debate the results of QE in the wake of the recession. Fed officials and others say it helped stabilize the economy, increase lending, and boost employment. Other experts call the policy disappointing, noting the historically slow U.S. recovery and suggesting that it set the stage for post-pandemic inflationary conditions. Fears also remain that winding down, or “tapering,” the Fed’s asset purchases has contributed to market instability—leading to several so-called “taper tantrums.”

After 2014, with U.S. growth rebounding and unemployment falling, the Fed sought a to return to normalcy. QE purchases ended in 2014, though the Fed did not move to start gradually shrinking its balance sheet until 2017. The Fed also began slowly raising interest rates starting in December 2015, the first increase since 2006.

However, these efforts were interrupted in 2019, as the Fed became worried about slowing global growth and rising trade tensions. In July 2019, Powell announced he was cutting interest rates, which had reached 2.5 percent, and several more cuts followed that year. At the same time, the Fed again started buying assets, at a pace of $60 billion per month, in an attempt to calm volatile financial markets. The pandemic led to an acceleration in purchases as the Fed sought to contain an economic crisis; the bank’s balance sheet doubled between 2020 and 2022, reaching nearly $9 trillion.

What did Dodd-Frank do?

In the wake of the 2008 financial crisis, Congress passed the 2010 Dodd-Frank Act, short for the Dodd-Frank Wall Street Reform and Consumer Protection Act. The legislation seeks to reduce systemic risk through a wide range of policies, including new limits on derivatives trading, stricter oversight of banks, and greater consumer protections. A major plank is the so-called Volcker Rule, named after the former Fed chair, which prohibits federally backed banks from proprietary trading, or making risky bets with their depositors’ funds.

Dodd-Frank introduced what is essentially a third official mandate for the Fed, alongside its inflation and employment targets, by expanding its oversight of the financial system. It does that in part via the Fed’s participation in the newly created Financial Stability Oversight Council, which identifies risks to the system and imposes new regulations as needed.

The Fed is also now in charge of keeping a closer eye on banks’ solvency, so it can ensure they have enough reserves to survive another major downturn. All financial firms big enough to pose a risk to the broader economy—known as “systemically important financial institutions”—are evaluated yearly with so-called “stress tests” that simulate the conditions of an economic crisis. These policies together represent a consolidation of oversight in Washington—previously, the regional reserve banks, and the New York Fed in particular, took the lead on regulating banks in their territory. In 2018, Trump signed legislation weakening the Volcker Rule, reducing the number of banks subject to stress tests, and rolling back other Dodd-Frank provisions. Some economists argue that these rollbacks helped create the conditions for the 2023 collapse of Silicon Valley Bank—the third largest bank failure in U.S. history.

How has the Fed responded to post-COVID inflation?

Beginning in early 2020, the pandemic emerged as a major global economic disruption. That March, the Fed responded with an immediate return to its emergency footing, cutting rates to zero and announcing a slew of measures to bolster markets and pump money into the financial system. With an aggressive Fed response and unprecedented fiscal stimulus, the economic recovery was much faster than the one following the Great Recession. However, the stimulus—in conjunction with depressed demand from lockdowns, snarled supply chains, and high global energy prices following Russia’s invasion of Ukraine—contributed to the highest inflation rate since the early 1980s. This inflationary environment led the Fed to use interest rate hikes to try to cool off the economy while avoiding a recession—a goal known as a “soft landing.”

Fed officials initially viewed the higher inflation as temporary. But as higher prices continued, they began lowering interest rates in 2022 at their fastest rate in forty years. Critics of the Fed’s policy argued that the bank realized the persistent nature of inflation too late, forcing it to raise interest rates more aggressively and risk a recession.

Meanwhile, the Fed’s actions have reverberated beyond the U.S. economy. Its persistent tightening put pressure on other central banks to raise their interest rates to prevent their currencies from falling further against the surging U.S. dollar, writes CFR’s Brad W. Setser, a former U.S. Treasury official. When Japan—where interest rates were far lower than in the United States—raised rates in July 2024, a series of bets on the low value of the yen relative to the U.S. dollar unraveled, leading to a short-lived collapse in the largest Japanese stock index and an associated drop in major American indices. After months of debate among economists over when to begin lowering rates, Powell signaled in July 2024 that cuts could soon begin; reductions were subsequently made in September, November, and December. Some experts, including CFR’s Roger W. Ferguson, a former Fed vice chairman, cautioned that cutting rates too soon could make inflation harder to contain.

In 2025, the Fed has come under renewed political pressure from Trump for not cutting rates more aggressively. In a July meeting, where the bank announced it would hold rates steady for the fifth-straight time, two Fed governors voted against the majority for the first time in three decades. Chief among Trump’s demands is lower interest rates to reduce the cost of servicing ballooning federal deficits and stimulate economic growth—especially urgent as Trump’s tariff policies threaten economic downturn. Powell has said that such policies could result in a “challenging scenario” for the central bank due to the potential for rising inflation and slow growth. Trump’s repeated attacks on Powell have raised concerns among economists, who warn that politicizing the bank could damage investor confidence and drive up long-term borrowing costs. 

CFR’s Rebecca Patterson pointed to Hungary and Turkey as cautionary examples of what happens when central banks become politicized. In both countries, government interference led to weaker currencies, surging inflation, and sovereign credit downgrades. Undermining the Fed’s independence could have serious global repercussions given the United States’ centrality in the global financial system. “Without that stability and predictability,” Patterson noted, “the nation is in danger of losing what makes its economy and financial markets exceptional.”