How the Fed and Congress Shape America’s Financial System

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The Federal Reserve and Congress both steer the U.S. economy, but with different tools. The Fed, the nation’s central bank, influences interest rates: a rate increase can make borrowing less attractive while raising the interest banks pay on deposits. Congress and the president determine federal taxes and spending.

For a household saving to buy a home, more interest on its savings may help build the money for the purchase, while a higher borrowing cost may still put the mortgage payment out of reach. Taxes and spending reach the same household by another route, so an announcement from one institution cannot settle what that household can afford.

Two institutions, different powers

Monetary policy is the work of a central bank to influence economic conditions, including employment, prices and growth. The Federal Reserve Act directs the Fed to promote maximum employment, stable prices and moderate long-term interest rates.

Fiscal policy means government tax and spending policy; in the United States, Congress and the administration determine it, and the Fed does not. For federal funding bills, both houses of Congress must pass the same version before sending it to the president to sign or veto. A spending law and a rate cut work differently: the law directs public money to a use, while a rate cut still depends on people and businesses choosing to borrow and spend.

The Fed also has responsibilities for financial stability, the safety of financial institutions, payment systems, consumer protection and community development.

How a Fed decision reaches borrowing costs

The federal funds rate is the interest rate at which banks lend balances held at the Fed to one another overnight. The Fed helps keep that rate within the target range set by its policy committee, by paying banks interest on those balances and by using overnight reverse repurchase transactions. In these transactions, the Fed sells a security and agrees to buy it back the next day. Eligible participants include banks and money market funds. Money market funds are mutual funds that invest in high-quality, short-term debt.

Both tools make a set return available on money held at the Fed, which limits how far money market rates can fall. The starting point is a market for short-term funds, rather than a government price list for every consumer loan.

Fed rate changes also reach savers: banks can pass some of a change in the federal funds rate through to the interest paid on deposits. Deposit rates and loan rates need not move by equal amounts, so a rate increase can add more to a household’s borrowing cost than to the interest on its savings.

When monetary policy lowers interest rates on consumer loans, financing purchases such as cars and appliances becomes easier, encouraging spending. Lower mortgage rates can also make homes more affordable and encourage homeowners to refinance.

Long-term loan rates reflect expectations about monetary policy and the broader economy over the life of the loan, not just the current federal funds rate. A change in the Fed’s short-term target therefore does not promise an identical change in a mortgage quote.

Lower rates can support employment by lifting demand for things bought with credit, including business investment and housing. Higher rates can restrain inflation, but they also risk reducing employment.

Monetary policy affects economic activity, employment and prices with a lag. A decision is a change in conditions that people and businesses respond to over time, rather than an immediate instruction to hire, spend or lower prices.

Who runs the Fed and who can hold it accountable

The Federal Open Market Committee, or FOMC, sets the target range for the federal funds rate. It has 12 members: the seven members of the Fed’s Board of Governors, the New York Federal Reserve Bank president and four other Reserve Bank presidents serving in rotating seats. Reserve Bank presidents without a vote still attend meetings and participate in the discussions.

The president nominates Fed governors and the Senate confirms them; a full governor’s term is 14 years, with staggered expiration dates. The president also nominates the chair from among the governors, subject to Senate confirmation, for a renewable four-year term. Because terms are staggered, the Board’s makeup changes through several appointments over time, not only through the choice of chair.

Congress gives the Fed operational independence in monetary policy while keeping it accountable to lawmakers and the public. The Fed explains the purpose as allowing decisions based on evidence and analysis without taking politics into consideration.

That independence is a product of congressional legislation, so Congress can reduce it by passing a law, with the president’s approval or over a veto. An appointment changes who exercises the delegated power; rewriting the statute can change the power itself.

The Fed submits a Monetary Policy Report to Congress twice a year, accompanied by testimony from the chair to the Senate Banking and House Financial Services committees.

The Government Accountability Office, or GAO, reviews Fed activities every year, and an outside auditor audits the Board’s financial statements annually. Federal law limits GAO audits in specified areas, including monetary-policy deliberations, decisions and actions. Those limits do not mean the Fed is never audited.

Congress changes taxes, spending and borrowing

Congress sets discretionary agency funding annually, while mandatory spending covers payments required by law, such as Social Security and Medicare.

Government purchases of goods and services add directly to economic activity, while transfers to individuals can support it as recipients spend the money. An income-tax cut leaves people with more disposable income, the money available to spend, and can increase demand for goods and services. Two measures intended to increase spending can reach people differently: a cheaper loan matters to someone borrowing, while a transfer matters to the person receiving it.

Some responses happen through laws already in place: automatic stabilizers reduce taxes and increase spending as the economy weakens, without a new congressional vote. Examples include the progressive income-tax system and unemployment compensation. A widening deficit can therefore reflect a weaker economy as well as a new decision to provide stimulus.

When spending exceeds revenue, the federal government runs a deficit and borrows by selling Treasury securities, including bills, notes and bonds. The national debt reflects accumulated borrowing rather than only one year’s shortfall.

The debt limit is the total amount the government is authorized to borrow to meet its existing legal obligations; it does not authorize new spending commitments.

Persistent fiscal stimulus, particularly during an expansion, can limit long-term growth by crowding out private investment, meaning government borrowing leaves less room for it. Rising public debt can also direct more of the budget toward interest payments, limiting room for other priorities.

When policies pull in different directions

A tax cut or spending increase can support demand while higher interest rates discourage purchases made on credit. Estimates of what such a stimulus will do depend partly on how the Fed responds, whether by accommodating the change or offsetting it, and on uncertain responses by households and businesses.

The FOMC’s longer-run inflation goal is 2 percent, measured by the annual change in the personal consumption expenditures price index, a measure of consumer prices. A longer-run goal describes the destination for policy, rather than a promise that every year’s inflation will land exactly there.

The committee does not set a fixed numeric employment goal because maximum employment is not directly measurable and changes with the labor market. Its assessments of that level are uncertain and subject to revision.

The employment and inflation goals are generally complementary. When the committee judges they are not, it follows a balanced approach, weighing how far each is from its goal and how long each is projected to take to return. A disagreement over rates can therefore be about how to balance employment and inflation, even when both sides accept the Fed’s goals.

A Fed note on the 2025 review of its monetary-policy framework said inflation became far too high not long after 2020 as a result of unprecedented shifts in demand and supply induced by the COVID-19 pandemic. That is the Fed’s own account. Read that way, the episode cautions against treating either institution’s decisions as the sole explanation for every change in prices or employment.

Financial crises test the division of power

The Fed supervises institutions including bank holding companies, generally companies that control banks, and state-chartered banks that belong to the Federal Reserve System. It shares financial-safety responsibilities with other regulators, including the Federal Deposit Insurance Corporation, or FDIC, and the Office of the Comptroller of the Currency.

Supervision does not tell a depositor how much of a deposit is insured. The FDIC’s standard deposit-insurance limit is $250,000 per depositor, per insured bank, per account ownership category. Depositors weighing safety need to check those limits against their own accounts.

The Fed’s discount window provides loans to depository institutions, financial institutions legally permitted to accept deposits, such as banks and credit unions. Its primary-credit program serves generally sound institutions as a backup source of funding. Every discount-window loan must be backed by collateral acceptable to the lending Reserve Bank: assets pledged to secure repayment.

Broader emergency lending under Section 13(3) of the Federal Reserve Act is limited to programs with broad-based eligibility approved by the Treasury secretary. Broad-based means at least five entities would be eligible and the program is not designed to aid failing firms. Lending to insolvent entities is prohibited as well. Insolvency includes failing to pay undisputed debts as they come due during the preceding 90 days, or being determined insolvent by the Board or lending Reserve Bank.

In the 2008 financial crisis, Congress authorized the Troubled Asset Relief Program, or TARP, through the Emergency Economic Stabilization Act. The Treasury Department oversaw TARP, whose programs were meant to stabilize the financial system. By December 2008, the Fed had cut its rate target to near zero, yet the economy still needed substantial support.

In response to the crisis, the Fed also bought roughly $3.7 trillion in longer-term Treasury and other securities over six years, increasing demand for those assets and putting downward pressure on longer-term interest rates. The crisis illustrated both sides of the division: Congress could authorize a Treasury program to stabilize the financial system, while the Fed moved beyond ordinary rate cuts.

During the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, authorized at least $454 billion for the Treasury to support Fed lending facilities. With the Treasury secretary’s approval, the Fed used its emergency authority to establish nine facilities backed by those funds.

Use of those facilities was relatively limited: as of November 15, 2020, they had used about $24 billion, a little more than 1 percent of the $1.95 trillion in transactions the Fed could back with that support, GAO found. By November 15, 2020, Treasury had committed $195 billion and paid out $102.5 billion to protect the Fed against potential losses; the Fed funded the loans and asset purchases. Representatives of small businesses, banks, and state and local governments told GAO that the terms of some facilities deterred some potential participants, and some small businesses may prefer not to take on more debt. GAO also noted that the facilities are designed to function as backstops. Judging the response means asking what the facilities were meant to do and whether a loan was a suitable form of help for the intended recipients, not only how much credit was used.

Following the decisions that matter

FOMC policy statements appear after each meeting, and detailed minutes are released three weeks after regularly scheduled meetings. Chair press conferences and quarterly economic projections provide further public information about the committee’s decisions and outlook.

For the spending side, USAspending.gov tracks how federal agencies and programs use budgeted money. USA.gov’s elected-officials directory provides contact information for senators and representatives. Those are the people to contact about taxes or program funding; for a rate decision, the FOMC’s statements and minutes explain what was decided.