Chapter 14. Structure of Central Chapter 14. Structure of Central Banks & the Federal Reserve Banks & the Federal Reserve

SystemSystem

Chapter 14. Structure of Central Chapter 14. Structure of Central Banks & the Federal Reserve Banks & the Federal Reserve

SystemSystem

• Origins

• Structure

• Independence

• Origins

• Structure

• Independence

I. OriginsI. OriginsI. OriginsI. 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. StructureII. StructureII. StructureII. Structure

• 3 parts: Federal Reserve Banks Board of Governors FOMC

• 3 parts: Federal Reserve Banks Board of Governors FOMC

1. Federal Reserve Banks1. Federal Reserve Banks1. Federal Reserve Banks1. 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 DIDMCA1980 DIDMCA1980 DIDMCA1980 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 Governors2. Board of Governors2. Board of Governors2. 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. FOMC3. FOMC3. FOMC3. 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 & realityFed structure & realityFed structure & realityFed structure & reality

• appears decentralized

• but power concentrated w/ Board of governors Chair

• appears decentralized

• but power concentrated w/ Board of governors Chair

III. Fed IndependenceIII. Fed IndependenceIII. Fed IndependenceIII. 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 independencesources of independencesources of independencesources 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 Fed independence is not complete!complete!Fed independence is not Fed independence is not complete!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?Is independence good?Is independence good?Is independence good?

• common in industrialized countries

• but it is undemocratic• common in industrialized countries

• but it is undemocratic

ProsProsProsPros

• 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: 1981-82 recessionexample: 1981-82 recessionexample: 1981-82 recessionexample: 1981-82 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

ConsConsConsCons

• 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 aheadLooking aheadLooking aheadLooking 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)