Structure and Accountability of the Federal Reserve System

1. Chapter 17 Who’s in Charge Here?

2. Key Topics • Structure and Purpose of the Federal Reserve System • Controversies and Benefits of Central Bank independence

3. Monetary Policy • Congress created Federal Reserve in 1913 to conduct Monetary policy of U.S. • Important Question of the Chapter • To whom is the Federal Reserve responsible?” • Is it the President who appoints the seven members of the Board of Governors. • Is it the Congress who created it. • Is it the member banks

4. Structure of the FED • Feature: • Decentralization • Blend of public and private authority • Power is widely diffused • No person, group, or sector can dominate the monetary policy

5. Organization • Board of Governors • 7 members • 14 year terms • Appointed by US President • Approved by the Senate • Selection: • No two members from same Federal Reserve district • Any of the 12 Federal Reserve district can contribute only one member • Chairman of Board • Selected by President from Board with 4 year term • Term can not coincide with presidential term

6. Organization • Board of Governors • Budgetary Independence • Independent of congressional appropriations process • Partly exempt from audit by General Accounting Office (GAO) • Operating funds come from earnings of the 12 regional banks

7. Organization • Regional Banks • 12 regional Federal Reserve banks dispersed throughout the nation • Each regional banks supervises and regulates the member banks • Technically each regional bank is privately owned by member banks

8. Federal Reserve System

9. Structure • Regional Banks • 9 Directors • Member banks elect 6 of 9 directors • Remaining 3 appointed by Board of Governors • President • Nine directors select the president of their regional bank • Approved by the Board of Governors • Federal Advisory Council • Each regional bank selects a representative • Makes recommendations regarding conduct of monetary policy

10. Organization • Legal authority of Fed • Diffused with respect to the execution of monetary policy • Reserve Requirement • Board of Governors sets the reserve requirements on bank deposits • These rates are subject to limits imposed by Congress

11. Organization • Federal Open Market Committee [FOMC] • Directs open market operations • Buying and selling U.S. government securities • Executed by the Federal Reserve Bank of New York

12. Structure • Federal Open Market Committee [FOMC] • Composed of 12 members • Seven members of Board • Five of regional bank presidents • The president of the New York Fed is a permanent member of the FOMC • Four remaining seats are rotated annually among the remaining eleven regional banks

13. Structure Legal authority of Fed • Discount rates • “Established” every 2 weeks by directors of the regional Fed • Subject to “Review and Determination” of Board of Governors • Confusion as to where final authority and responsibility lie

14. The Realities of Power • Chairman of the Board of Governors of Federal Reserve • Dominant figure in formation and execution of monetary policy • Most influential member of the FOMC • Recognized as the voice of the Fed • Chairman is embodiment of US central bank • What is name of this person?

15. Evolution of FED • Evolution of power of the Fed • The Federal Reserve was first established as a passive service agency • Supplying currency • Clearing checks • Providing discount facility • No idea of monetary policy as an active countercyclical force

16. Evolution of FED • Evolution of power of the Fed • Shifting role of central bank • Responsibility for monetary policy has become centralized and concentrated in Washington • Shifted from passive accommodation to active regulation • Rise in power of central bank and decline in role of regional banks • Central bank as headquartered in Washington with 12 field offices

17. Evolution of FED • Power of the Board’s professional staff of economic experts and advisers • Long tenure with the Fed • Familiarity with history of the Fed • Expertise in monetary analysis • Exert significant influence on ultimate decision-making process

18. Evolution of FED • Power of the FOMC • Statutory authority is confined to directing open market operations • However, all policy matters are reviewed at FOMC meetings • Role of member banks • They do “own” their regional bank—mostly symbolic • Major voice in electing directors of regional banks who have largely ceremonial responsibilities

19. Problem of Fed’s Independence • Federal Reserve is a creature of the Congress • Constitution of US gives Congress power to “coin money and regulate the value thereof” • The Federal Reserve was created in 1913 to administer this responsibility of Congress

20. Problem of Fed’s Independence • Federal Reserve is a creature of the Congress • Congress requires periodic accountability by Fed • Can amend Federal Reserve Act at any time • Essentially, Congress has given the Fed a broad mandate to regulate monetary system

21. Problem of Fed’s Independence • Congressional concern over status of FED • Concern over • Freedom from congressional appropriations • Exemption from government audit • Questioning of the Fed’s handling of monetary policy—political differences • Complain Fed has not done a good job and perhaps Congress should establish guidelines to limit discretion of Fed

22. Problem of Fed’s Independence • Relationship between Federal Reserve and the President • Should Fed be responsible to the President? • Monetary policy is one component of administration’s total economic program and should be coordinated at highest executive level • Placing Fed under executive control might invite excessive money creation and inflation

23. Problem of Fed’s Independence • Relationship between Federal Reserve and the President • The more independent the central bank—lower inflation • Might sacrifice monetary stability to government’s revenue needs—printing money • The sole purpose of an independent monetary authority is to forestall the natural propensity of governments to resort to inflation

24. Independence and Inflation