Chapter 17

Who’s in Charge Here?

Key Topics

Structure and Purpose of the Federal Reserve System

Controversies and Benefits of Central Bank independence

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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

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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

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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 term17-5

Structure and Policy organization

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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

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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

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Federal Reserve System

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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

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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

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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

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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

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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

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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?

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Realities of the power within the Federal Reserve System.

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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

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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

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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

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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

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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

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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

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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

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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

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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

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Independence and Inflation

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