The Organization of The Fed
and other Central Banks
A Brief History of Central Banks
• A Central Bank is an entity responsible for overseeing a nation’s
banking system, acting as a lender of last resort, conducting
monetary policy, and maintaining currency stability.
– The two oldest Central Banks are the Swedish Riksbank (1668) and the
Bank of England (1694), though elements of Central Banking have been
around since the introduction of fiat money by the Mongols in the 13th
century.
• The Central Bank in the U.S., the Federal Reserve System, was not
created until 1913
– Fear of centralized power along with a distrust of moneyed interests
halted earlier attempts at creating a central bank
– A series of bank failures, culminating in panic of 1907 overcame these
fears and paved the way for the “Fed.”
– To limit the centralization of power or influence by any one group, the
Fed was subjected to checks and balances among private vs. public
interests as well as national vs. regional
Checks and Balances at the Fed
The Federal Reserve System
Federal Reserve Banks
•
Quasi-public institution owned by private commercial banks in the district
that are members of the
Fed system
– Member banks purchase stock in their regional Federal Reserve Bank as a
requirement of membership
•
Member banks elect six directors (A and B) for each district; three more
(C) are appointed by the Board of Governors
– Three A directors are professional bankers
– Three B directors are prominent leaders from industry, labor, agriculture, or
consumer sector
– Three C directors appointed by the Board of Governors
are not allowed to be officers, employees, or stockholders
of banks
– These nine directors at each bank then nominate a bank president to be
confirmed by the Board of Governors
•
By drawing directors from all sectors of the economy, no one industry
can dominate the Fed’s actions
5
The Functions of each Federal Reserve Bank
•
•
•
•
•
•
•
•
•
Clear checks
Issue new currency
Withdraw damaged currency from circulation
Manage discount loans to banks in each district
Evaluate and advise on M&A activity between banks in
each district
Connect the local business community and the
Federal Reserve System
Examine and advise local banks
Collect data on local business conditions
Conduct research into the conduct of monetary policy
6
Monetary Policy and the Fed
• The directors of the Federal Reserve Banks establish the
discount rate at which commercial banks borrow from the Fed.
– The Board of Governors have the right to review and determine this
rate.
• The directors also decide which banks (both members and nonmembers) may borrow from the Fed at this discount rate
• The directors select one commercial banker from each district to
sit on the Federal Advisory Council, which advises the Board of
Governors about monetary policy
• ***Five of the bank presidents has a vote (along with the seven
members of the Board of Governors) in the Federal Open Market
Committee, the main arm of monetary policy***
– All twelve bank presidents attend FOMC meetings, but only five vote.
– One vote always goes to the president of the New York Fed, while
the other four rotate on an annual basis.
7
The Members of the Fed
• All national commercial banks are required to be members of the
Federal Reserve System
– A national bank operates in more than one state and is chartered by
the Office of the Comptroller of the Currency.
– Membership entails purchasing stock in the commercial bank’s
regional Federal Reserve Bank
• This stock cannot be traded or sold and pays a fixed 6% annual dividend.
• State-chartered banks can be members of the Fed, but are not
required to do so.
– In the past, many state-chartered banks preferred not to become Fed
members since they didn’t want to keep reserves as deposits at the
Fed (where they earned no interest)
– The Depository Institutions Deregulation and Monetary Control Act of
1980 required all commercial banks (members and non-members
alike) to abide by the same reserve requirements.
• The majority of banks in the US are not members of the Fed, but
majority of assets are controlled by members.
8
Members and Non-Members of the Fed
National State Bank State Bank
(Member) (Non-Member)
Bank
The Board of Governors
• Seven of the twelve votes on the FOMC go to the Board of
Governors of the Federal Reserve System
• Each governor is appointed by the US President and confirmed
by the US Senate to a single (non-renewable) 14 year term
– The seven governors must come from different districts to prevent
regional dominance
• The Chairman of the Board of Governors is selected from this
group and subject to reappointment every four years by the U.S.
President.
• The Board has the most policy control in the Fed as it has…
– A voting majority in the FOMC
– Sets reserve requirements within legislative limits
– Effectively controls the discount rate with its mandate to “review and
determine” the rate set by the 12 Regional Banks.
10
The FOMC
• When the media reports that “the Fed met to lower interest rates,”
what they are really talking about is the FOMC
• The FOMC meets eight times per year (every six weeks) on a
Tuesday.
• The FOMC is made up of the seven-member Board of Governors
and five Regional Bank presidents (one of whom is always the
president of the NY Fed)
– The other seven Bank presidents attend and participate in
discussions, but do not vote.
• The FOMC meetings set a “Federal Funds Rate” that will be
targeted through the Open Market Operations of buying and
selling treasury bonds from/to the public.
11
The FOMC
•
At each FOMC meeting, three important reports are discussed:
– The “Green Book” presents forecasts by the Fed research staff on the state
of the economy over the next two years
– The “Blue Book” presents a favored monetary policy objective as well as
three alternative policies to be considered.
– The “Beige Book” presents surveys and reports on the state of the economy
in each of the twelve districts.
•
Upon voting (generally in agreement with the Chairman), a public
announcement is made about the outcome of the meeting as well as the
economic trends prompting any policy changes
– The public announcement is a new development since 1994 and represents a
growing trend toward transparency.
•
The Chairman has a very powerful position within the FOMC (and by
extension, the FED)
–
–
–
–
Spokesperson for the Fed in talks with Congress and the US President
Sets the agenda for meetings
Speaks and votes first about monetary policy
Supervises the professional economists from whose ranks the Board of
Governors is most frequently selected.
12
The European Central Bank
• For much of the post-WWII period, the Fed was the most
important central bank in the world.
– This hegemony has been challenged since 1999 with the creation of
the European Central Bank (ECB) and European System of Central
Banks (ESCB)
• Following the mandates laid out in the Maastricht Treaty of 1992,
eleven countries adopted a single currency (the euro) and ceded
control of monetary policy to the ECB in January 1999.
– There are now fifteen countries using the euro, with more slated to
join over the next decade.
• Each country’s central bank stayed in business, but now operates
much like the Regional Reserve Banks in the US do.
• Monetary Policy is established at the ECB, by the Governing
Council
– The Executive Board consists of the President and Vice President of
the ECB along with four other members appointed to eight year nonrenewable terms
– The fifteen presidents of the National Central Banks
13
Central Bank Independence
• Consider three measures of Central Bank Independence:
– Instrument independence  the central bank is free to set any
monetary policy instrument/variable
– Goal independence  the central bank is free to set its own goals for
monetary policy
– Political independence  the central bank is able to conduct
monetary policy without legislative influence
• Both the Fed and the ECB are considered to be very independent
central banks
– The ECB has less goal independence as it has a mandate to
promote price stability (2% inflation target recently)
– However, changes to the ECB cannot be made without a unanimous
change to the Maastricht Treaty (by 15 countries!)
– Changes to the Fed may be made by a simple act of Congress.
• Political independence is built into the structure of these
organizations
– Long and non-renewable terms
– Financed out of their own revenues rather than by legislative
approval
15
Should central banks be independent of political influence?
• The strongest argument for independence is that an independent
central bank is insulated from the political pressures of re-election
– Fiscal policy tends to follow a “political business cycle” inflationary
during an election year, contractionary afterwards.
– If central banks were subject to political approval, monetary policy
would also follow this volatile pattern
• Another argument in favor of central bank independence is that
elected politicians do not have the technical savvy to conduct
monetary policy
– Proponents of this view contrast the efficiency of a Federal Reserve
run by bureaucrats with the bloated Federal budget (often in deficit)
run by politicians
• If the central bank was beholden to political interests, the federal
government could amass large budget deficits then turn to the
Fed to pay off its debts (essentially printing up more money for
the government to pay off its debts)
– Every time this has happened in history, massive inflation and
financial crises have been the result.
16
Should central banks be independent of political influence?
• Is it democratic to have monetary policy for the entire nation in
the hands of an “elite” group responsible to no one?
• If the Fed performs badly, there are few ways to replace its
members (unlike Congress where the people can vote out
underperforming legislators)
• If policy is best conducted by technically savvy elites, then why
aren’t all military decisions made by the Joint Chiefs of Staff, all
tax policy decisions made by the IRS, all environmental
regulations made by the EPA, etc.?
– This criticism gains credence when you consider that the Fed has
been a poor steward of the economy at times (failing to act early
enough during the Great Depression, inflating the economy during
the 1960’s.)
• Close coordination between monetary and fiscal policy would
achieve the most effective results. The best way to coordinate
both types of policies would be to have them controlled by the
same group.
17
Should central banks be independent of political influence?
• The empirical evidence on central bank independence
is mixed
– Some studies find evidence that the countries with the lowest
inflation rates are the most independent
– Other studies argue that while this is true, it is low inflation
rates that are causing central banks to become independent
18