CHP 13 on The Federal Reserve & Central Banks

ECON 2035

Chapter 13 - The Federal Reserve & Central Banks

Section 13.1: The Structure of the Federal Reserve System

  • Timeline of Events Leading to the Establishment of a Central Bank:

    • Resistance to Establishment:

    • Fear of centralized power and distrust of moneyed interests.

    • Lack of a lender of last resort led to regular nationwide bank panics.

    • Panic of 1907:

    • Severity prompted public consensus on the need for a central bank.

    • Key Proposals:

    • 1908: Monetary Commission formed.

    • 1912: Glass-Willis Proposal introduced.

    • 1913: The Federal Reserve Act passed, creating the Federal Reserve System.

Structure of the Federal Reserve System

  • Design Intentions:

    • Writers of the Federal Reserve Act aimed for diffusion of power across regional lines and between the private sector and government.

  • Entities of the Federal Reserve System:

    • Federal Reserve Banks

    • Board of Governors of the Federal Reserve System

    • Federal Open Market Committee (FOMC)

    • Federal Advisory Council

    • Approximately 2,900 member commercial banks

Structure and Responsibility for Policy Tools in the Federal Reserve System

  • Board of Governors:

    • Composed of seven members, including a chair, appointed by the U.S. President and confirmed by the Senate.

    • Responsibilities include:

    • Appointing three directors to each Federal Reserve Bank (FRB).

  • Twelve Federal Reserve Banks (FRBs):

    • Each with nine directors.

    • Six directors are responsible for appointing the president and other officers of the FRB.

    • Member banks elect six district bank directors.

  • Policy Tool Responsibilities of the Federal Reserve System:

    • Sets and reviews reserve requirements.

    • Establishes and directs:

    • Interest rates on excess reserves.

    • Open market operations.

    • Discount rate.

  • Federal Open Market Committee (FOMC):

    • Composed of seven Board of Governors members and presidents from the FRB of New York and four other FRBs.

    • Advises regarding monetary policy and operations.

  • Federal Advisory Council:

    • Twelve members (bankers), one from each district, providing advice to the Board of Governors.

Federal Reserve Banks and Their Locations

  • Map Overview of Federal Reserve Districts:

    • Major cities include:

    • Boston, New York City, Chicago, Minneapolis, San Francisco, etc.

    • Each district has its specific banks, offices, and functions.

  • Locations of District Banks Rationale:

    • Original intention was to provide more independence to district banks at their creation.

    • Some locations were politically influenced but largely determined by economic criteria.

Member Banks

  • Requirements for Membership:

    • Member banks must purchase stock in their District Bank.

    • Ownership helps ensure representation from banks, businesses, and the public in the board of directors.

  • Directors Composition:

    • Class A directors: Elected bankers.

    • Class B directors: Elected leaders from industry, commerce, agriculture.

    • Class C directors: Appointed by the Fed’s Board of Governors.

  • Functions of District Banks:

    • Manage check clearing, currency circulation, discount lending, and regulatory functions.

    • Provide economic data and supervise state member banks.

Special Role of the Federal Reserve Bank of New York

  • Unique Attributes:

    • Key for the health of the U.S. financial system due to the presence of large commercial banks.

    • Active in bond and foreign exchange markets, crucial for monetary policy.

    • Sole member of the Bank for International Settlements (BIS) among Federal Reserve Banks.

  • Leadership:

    • The New York Fed’s president acts as the only permanent voting member of the FOMC, alongside the chair and vice-chair of the Board of Governors as significant figures in monetary policy decision-making.

Board of Governors

  • Composition & Structure:

    • Governing board of the Federal Reserve System, comprising seven members appointed for 14-year, nonrenewable terms.

    • Headquarters located in Washington, DC.

    • Members are professional economists from various backgrounds.

  • Responsibilities:

    • Administers monetary policy, influences economic policy, and advises on financial regulations.

Chairman of the Board of Governors

  • Key Roles:

    • Advises the president, testifies before Congress, represents the Fed to the media, and may negotiate with foreign governments.

Role of the Research Staff

  • Research Function:

    • The largest employer of economists globally, providing data analysis and guidance on prospective economic directions and the implications of monetary policy.

The Federal Open Market Committee (FOMC)

  • Structure & Meetings:

    • Consists of 12 members including the Chairman of the Board of Governors and selected presidents from other Federal Reserve Banks.

    • FOMC meetings occur eight times a year to discuss open market operations and monetary policy strategies.

  • Meeting Procedures:

    • Reports on economic forecasts, policy scenarios, and relevant congressional actions are presented and discussed.

FOMC Communications and Publications

  • Color-Coded Reports:

    • Green Book: Detailed national economic forecasts.

    • Blue Book: Projections for monetary aggregates and policy scenarios.

    • Teal Book: Combination of the Green and Blue books (post-2010).

    • Beige Book: Regional economic evidence from surveys and discussions across Federal Reserve districts.

Power and Authority within the Fed

  • Historical Context:

    • Centralization of power in the Fed occurred after the Banking Acts of 1933 and 1935, shifting majority control to the Board of Governors.

    • Formal ownership by member banks does not equate to influence over monetary policy decisions.

The Influence of Federal Reserve Chairs

  • Different Styles of Leadership:

    • Distinguishing styles of different chairs like Ben Bernanke, Janet Yellen, and Jerome Powell compared to long-serving chair Alan Greenspan.

Changes to the Fed Under Dodd-Frank Act

  • Reforms Introduced in 2010:

    • Expanded Fed's role in regulations and oversight through new structures like the Financial Stability Oversight Council and Consumer Financial Protection Bureau.

    • Disclosure requirements for the Fed were also enacted to enhance transparency.

Section 13.2: How The Fed Operates

  • Handling External Pressure:

    • The Fed operates independently from external pressures and is self-funded through earnings generated from securities and services.

  • Conflict Examples with the Treasury:

    • Historical tensions during WWII and post-war periods regarding interest rates on Treasury securities.

    • Federal Reserve Accord of 1951 affirmed the Fed's independence from the Treasury.

Motivations Behind the Fed's Decisions

  • Public Interest View:

    • Theory that the Fed acts in the public interest aiming for price stability, employment, and growth; though evidence is mixed.

  • Principal-Agent View:

    • Suggests the Fed may act to maximize its power and influence rather than simply serving the public.

  • Political Business Cycle:

    • Speculation that the Fed may adjust policies to aid presidential incumbents' reelection efforts.

Communication Strategy of the Fed

  • Increased Transparency:

    • Following FOMC meetings, press conferences are held, and specific inflation targets are announced to clarify monetary policy.

Assessing Fed Independence

  • Factors Involved:

    • Instrument and goal independence alongside influence from presidential appointments and the congressional structure.

  • Arguments for Independence:

    • It allows for well-considered monetary policy free from political pressures which can potentially compromise economic stability.

  • Arguments Against Independence:

    • Critics argue elected officials should have more control over monetary policies for accountability and integration with fiscal policies.

Presidential Attacks on Fed Independence

  • Historical Context:

    • Previous presidents have attempted to influence Fed policies, and recent administrations differ in their respect for Fed independence.

Section 13.3: Central Bank Independence Outside of the U.S.

  • Degree of Independence Globally:

    • Central bank independence varies, with implications for economic policy and inflation targeting depending on national contexts and structures in place.

  • Comparative Overview:

    • The European Central Bank, Bank of Japan, and Bank of Canada have varying structures and levels of independence, influencing their respective monetary policies.

  • European Central Bank Specifics:

    • Charged with conducting monetary policy for eurozone countries, emphasizing price stability and independence from political pressures.