Chapter 14. Structure of Central Banks & the Federal Reserve System Origins Structure Independence Origins Structure Independence

I. Origins “the Fed” Federal Reserve Act 1913  response to panic of 1907 obstacles  fear of centralized power solution  decentralized structure “the Fed” Federal Reserve Act 1913  response to panic of 1907 obstacles  fear of centralized power solution  decentralized structure

II. Structure 3 parts:  Federal Reserve Banks  Board of Governors  FOMC 3 parts:  Federal Reserve Banks  Board of Governors  FOMC

1. Federal Reserve Banks 12 regional banks serve the member banks in that district -- all national banks -- option for state banks -- 33% of commerical banks 12 regional banks serve the member banks in that district -- all national banks -- option for state banks -- 33% of commerical banks

who controls district banks?  member banks are part owners -- 6% dividends -- part of Board of directors  other officers chosen by Board of Governors who controls district banks?  member banks are part owners -- 6% dividends -- part of Board of directors  other officers chosen by Board of Governors

functions  clear checks  provide/destroy currency  research regional economy -- Beige Book  economic education  monetary policy  approval of mergers, purchases FRBNY is most important district banks functions  clear checks  provide/destroy currency  research regional economy -- Beige Book  economic education  monetary policy  approval of mergers, purchases FRBNY is most important district banks

1980 DIDMCA all depository institutions  keep reserves on deposit at district bank  have access to discount loans all depository institutions  keep reserves on deposit at district bank  have access to discount loans

2. Board of Governors 7 governors  14-yr. terms (nonrenewable)  1 chair -- 4-year renewable term -- Alan Greenspan (1987) 7 governors  14-yr. terms (nonrenewable)  1 chair -- 4-year renewable term -- Alan Greenspan (1987)

Board helps set monetary policy  on FOMC  sets reserve requirement  approves district discount loan rates Board staff economists  economic research  collect data Board helps set monetary policy  on FOMC  sets reserve requirement  approves district discount loan rates Board staff economists  economic research  collect data

Board enforces regulations  permissible activities for banks  stock margin requirements  final say in bank mergers Board enforces regulations  permissible activities for banks  stock margin requirements  final say in bank mergers

3. FOMC Federal Open Market Committee 12 members  7 governors  FRBNY President  4 other district bank presidents Federal Open Market Committee 12 members  7 governors  FRBNY President  4 other district bank presidents

meet every 6 weeks  assess condition of economy  vote on monetary policy -- announce decision later that day (since 1996) meet every 6 weeks  assess condition of economy  vote on monetary policy -- announce decision later that day (since 1996)

FOMC & monetary policy  voting on federal funds rate target  voting on open market operations -- buying & selling of Treasury debt by the Fed FOMC & monetary policy  voting on federal funds rate target  voting on open market operations -- buying & selling of Treasury debt by the Fed

Fed structure & reality appears decentralized but power concentrated w/  Board of governors  Chair appears decentralized but power concentrated w/  Board of governors  Chair

III. Fed Independence Fed has much more independence in decisions than other federal agencies Fed governors do NOT serve “at pleasure of the President” Fed decisions not subject to approval of President or Congress Fed has much more independence in decisions than other federal agencies Fed governors do NOT serve “at pleasure of the President” Fed decisions not subject to approval of President or Congress

sources of independence structure  Board of governors have long, nonrenewable terms  popularity of chairman w/ financial sector structure  Board of governors have long, nonrenewable terms  popularity of chairman w/ financial sector

financing  Fed is self-financing -- Treasury debt -- discount loans -- other services  Does not depend on Congress for funding financing  Fed is self-financing -- Treasury debt -- discount loans -- other services  Does not depend on Congress for funding

Fed independence is not complete! Congress has ultimate power to limit or eliminate Fed chairman testifies before Congress every 6 months Congress has ultimate power to limit or eliminate Fed chairman testifies before Congress every 6 months

Is independence good? common in industrialized countries but it is undemocratic common in industrialized countries but it is undemocratic

ProsPros political goals often conflict with economic goals  short term vs. long term goals  Congress: re-election  Fed: free to pursue unpopular policies in short-run -- price stability may require slower economic growth political goals often conflict with economic goals  short term vs. long term goals  Congress: re-election  Fed: free to pursue unpopular policies in short-run -- price stability may require slower economic growth

example: recession Fed chair Paul Volcker slowed down economy to control inflation  “Volcker Recession”: ’81-’82 results of low inflation:  2 long expansions in 1980s, 1990s Fed chair Paul Volcker slowed down economy to control inflation  “Volcker Recession”: ’81-’82 results of low inflation:  2 long expansions in 1980s, 1990s

ConsCons Fed not accountable for mistakes  stuck with bad governors independence is no guarantee of success  Fed did not prevent bank failures of Great Depression  inflation of 1970s Fed not accountable for mistakes  stuck with bad governors independence is no guarantee of success  Fed did not prevent bank failures of Great Depression  inflation of 1970s

independent Fed does not coordinate policy with Congress  monetary vs. fiscal policy independent Fed does not coordinate policy with Congress  monetary vs. fiscal policy

Looking ahead money supply process (15 & 16) tools used by Fed for to control money supply (17) Fed use of monetary policy (18) money supply process (15 & 16) tools used by Fed for to control money supply (17) Fed use of monetary policy (18)