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Money and the Federal Reserve System: Myth and Reality

The United States, like virtually all advanced nations, has a banking system in which the use of fractional reserves means that most money is generated by banks and not the government. Presiding over this system is a central bank. The central bank for the United States, the Federal Reserve, has considerable independence in its operations, which include monetary policy.

This independence -- and the enormous influence that the Federal Reserve has over economic conditions -- have given rise to a great deal of conjecture concerning its nature and operations. The theories and suspicions about the system underlie monetary reform proposals frequently advanced by citizens, as well as various complaints and petitions sent to the Members of Congress because of congressional responsibility for the country's money.

The Federal Reserve is not a private corporation. It is part private and part public, with the Board of Governors an agency of the United States government. The regional Federal Reserve Banks are private corporations acting as agents of the government, owned by their member banks. No individuals hold stock in the Fed. Corporate control of the regional Federal Reserve Banks is limited and based on one vote per stockholding bank (so that big banks cannot control the system).

The Fed buys and owns some of the government's debt. But it does not determine how much debt is issued (that is determined by the government's budget). The Fed owns less than 10% of the government's total debt. The interest earned on the debt created by the Fed is turned over to the Treasury (except for an amount to cover the Fed's operating costs), so that the revenue consequences of having the Fed issue Federal Reserve notes is essentially the same as having its own currency directly.

Having a banking system that allows transactions to occur by check reduces the seigniorage revenue to the government, which could otherwise issue at a profit money needed for transactions. But bank depositors are the principal beneficiaries of the system, because they are able to earn interest on their accounts and minimize the amount of non-interest bearing cash they must hold for transaction purposes.

The existence of the Federal Reserve is separate from the choice of monetary standard. It is not an alternative to a gold standard. Similarly, the existence of the Federal Reserve and the choice of a monetary standard is unrelated to the existence of fractional reserve banking, or to who regulates the operations of banks. The primary issue about the Federal Reserve is about who controls monetary policy. (...)

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Source : Congressional Research Service Report for Congress, No. 96-672 E, Library of Congress, July 31, 1996.

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