by Investor Advocate Partners

Many individuals may not know why paper money is issued by the Federal Reserve and what role the Federal Reserve plays in the economy. Here’s an inside look.

Have you ever taken a close look at paper money? Each U.S. bill has the words “Federal Reserve Note” imprinted across the top.¹ But many individuals may not know why the bill is issued by the Federal Reserve and what role the Federal Reserve plays in the economy. Here’s an inside look.

Tip: Checks. Due to the onslaught of electronic check collection, the Federal Reserve now processes paper checks at just one location nationwide, down from 45 locations in 2003. Source: Board of Governors of the Federal Reserve System, 2016

The Federal Reserve, often referred to as the Fed, is the country’s central bank. It was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system.² Prior to its creation, the U.S. economy was plagued by frequent episodes of panic, bank failures, and limited credit.

The Fed has four main roles in the U.S. economy.³

Economy Watch

In addition to its other duties, the Fed has been given three mandates with the economy: maintain maximum employment, maintain stable price levels, and maintain moderate long-term interest rates.⁴

Fast Fact: Unwieldy Patchwork. In the early 1800s, the U.S. had no central bank and no common currency. The monetary system ran through a patchwork of state-chartered banks with no federal regulation. By 1860, there were nearly 8,000 of these banks, each issuing its own banknotes. Source: Federal Reserve Bank of San Francisco, 2018

It’s important to remember that “the Fed” cannot directly control employment, inflation, or long-term interest rates. Rather, it uses a number of tools at its disposal to influence the availability and cost of money and credit. This, in turn, influences the willingness of consumers and businesses to spend money on goods and services.

For example, if the Fed maneuvers short-term interest rates lower, borrowing money becomes less expensive and people may be motivated to spend. Consumer spending may stimulate economic growth, which may cause companies to produce more product and potentially increase employment. When short-term rates are low, the Fed closely monitors economic activity to watch for signs of rising prices.

On the other hand, if the Fed pushes short-term rates higher, borrowing money becomes more expensive and people may be less motivated to spend. This may, in turn, slow economic growth and cause companies to decrease employment. When short-term rates are high, the Fed must watch for signs of a decline in overall price levels.

Supervise and Regulate

The Fed establishes and enforces the regulations banks, savings and loans, and credit unions must follow. It works with other federal and state agencies to ensure these financial institutions are financially sound and consumers are receiving fair and equitable treatment. When an organization is found to have problems, the Fed uses its authority to have the organization correct the problems.

Financial System

The Fed maintains the stability of the financial system by providing payment services. In times of financial strain, the Fed is authorized to step in as a lender of last resort, providing liquidity to an individual bank or the entire banking system. For example, the Fed may step in and offer to buy the government bonds owned by a particular bank. By so doing, the Fed provides the bank with money that it can use for its own purposes.

Banker for Banks, U.S. Government

The Fed provides financial services to banks and other depository institutions and to the U.S. government. For banks, savings and loans, and credit unions, it maintains accounts and provides various payment services, including collecting checks, electronically transferring funds, distributing new money, and receiving and destroying old, worn-out money. For the federal government, the Fed pays Treasury checks; processes electronic payments; and issues, transfers, and redeems U.S. government securities.

Each day, the Fed is behind the scenes supporting the economy and providing services to the U.S. financial system. And while the Fed’s duties are many and varied, its focus is to maintain confidence in banking institutions.

1. U.S. Bureau of Engraving and Printing, 2018
2, 4. Federal Reserve Bank of San Francisco, 2018
3. Board of Governors of the Federal Reserve System, 2016

For many people, retirement income may come from a variety of sources. Here’s a quick review of the six main sources:

Social Security

Social Security is the government-administered retirement income program. Workers become eligible after paying Social Security taxes for 10 years. Benefits are based on each worker’s 35 highest earning years. If there are fewer than 35 years of earnings, non-earning years are averaged in as zero. In 2019, the average monthly benefit was estimated at $1,461.¹

Personal Savings and Investments

Personal savings and investments outside of retirement plans can provide income during retirement. Retirees tend to go for investments that offer monthly guaranteed income over potential returns.²

Individual Retirement Accounts

Traditional IRAs have been around since 1974. Contributions you make to a traditional IRA may be fully or partially deductible, depending on your individual circumstances. Distributions from a traditional IRA are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 70½, you must begin taking required minimum distributions.

Roth IRAs were created in 1997. Roth IRA contributions cannot be made by taxpayers with high incomes. To qualify for the tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½. Tax-free and penalty-free withdrawals also can be taken under certain other circumstances, such as a result of the owner’s death. The original Roth IRA owner is not required to take minimum annual withdrawals.

Defined Contribution Plans

Many workers are eligible to participate in a defined-contribution plan such as a 401(k), 403(b), or 457 plan. Eligible workers can set aside a portion of their pre-tax income into an account, which then accumulates, tax deferred.

Distributions from defined contribution plans are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 70½, you must begin taking required minimum distributions.

Defined Benefit Plans

Defined benefit plans are “traditional” pensions—employer–sponsored plans under which benefits, rather than contributions, are defined. Benefits are normally based on factors such as salary history and duration of employment. The number of traditional pension plans has dropped dramatically during the past 30 years. 

Continued Employment

In a recent survey, 68% of workers stated that they planned to keep working in retirement. In contrast, only 26% of retirees reported that continued employment was a major or minor source of retirement income.³