Chapter 13

Central Banks and the Federal Reserve System

Structure of the Federal Reserve System

  • The Federal Reserve System is composed of three branches with overlapping responsibilities:

    • 12 Regional Federal Reserve Banks (referred to as "regional Feds")

    • Board of Governors (referred to as "the Board") located in Washington, D.C.

    • Federal Open Market Committee (FOMC)

12 Regional Federal Reserve Banks

Locations:

  • Seattle

  • Portland

  • San Francisco

  • Salt Lake City

  • Los Angeles

  • Minneapolis

  • Boston

  • Buffalo

  • Detroit

  • New York

  • Chicago

  • Pittsburgh

  • Philadelphia

  • Cleveland

  • Cincinnati

  • Baltimore

  • Kansas City

  • Denver

  • Richmond

  • St. Louis

  • Louisville

  • Charlotte

  • Memphis

  • Nashville

  • Oklahoma City

  • Little Rock

  • Dallas

  • El Paso

  • Houston

  • San Antonio

  • Atlanta

  • Birmingham

  • Jacksonville

  • New Orleans

  • Miami

  • (Alaska and Hawaii are in District 12)

Federal Reserve Banks (Regional Feds)

  • Characteristics:

    • Quasi-public institutions

    • Each regional Fed has 9 directors designed to reflect various constituencies:

    • Member banks elect 6 directors

      • 3 bankers

      • 3 representatives from industry/labor/agriculture/consumer groups

    • Board of Governors elects the remaining 3 directors

    • The 6 non-banker directors appoint the President of each regional Fed, with approval from the Board of Governors

  • FOMC Participation:

    • Presidents of the regional Feds are part of the FOMC

    • NY Fed President is a permanent voting member and serves as vice-chair

    • 4 of the other 11 presidents vote on a rotating basis

Functions of the Regional Feds

Operational Functions:

  • Check clearing

  • Issue new currency and withdraw damaged currency

  • Make discount loans to banks in their districts

Regulatory Functions:

  • Conduct bank examinations

Monetary Policy Functions:

  • Collect data on local business and financial conditions

  • Conduct research on issues related to monetary policy and financial markets

  • Voting power in the FOMC on a rotational basis

  • NY Fed conducts open market operations

The Board of Governors (Fed Board)

  • Composition:

    • Seven members headquartered in Washington, D.C.

    • Appointed by the President and confirmed by the Senate

    • Serve 14-year non-renewable terms (overlapping and staggered)

    • All 7 members are voting members of the FOMC

  • Responsibilities:

    • Legally sets reserve requirements

    • Approves discount rates established by regional Feds

    • Invokes emergency lending authority during financial stress

  • Monetary Policy:

    • In practice, all monetary policy-related decisions are undertaken by the FOMC

  • Chair:

    • The chair of the Board (also chair of the FOMC) serves a four-year (renewable) term

    • Testifies before Congress and advises the President on economic matters

Most Recent Fed Chairs

  • Paul Volcker (1979-1987)

  • Alan Greenspan (1987-2006)

  • Ben Bernanke (2006-2014)

  • Janet Yellen (2014-2018)

  • Jerome Powell (2018-current)

Federal Open Market Committee (FOMC)

  • Meeting Frequency:

    • FOMC meets 8 times a year plus unscheduled meetings if necessary

  • Composition:

    • 12 voting members including 7 members of the Board, President of the NY Fed, and Presidents of four other regional Feds on a rotating basis

  • Meeting Structure:

    • Discuss “Staff forecast” (known as Green book forecasts) using econometric models such as FRB/US

    • Conduct a go-round discussion

    • Vote on the Monetary Policy Statement

Green, Blue, Teal, and Beige Books

  • The Green Book:

    • Detailed national forecast for the next three years placed between green covers (up until 2010)

  • The Blue Book:

    • Contains projections for monetary aggregates with three alternative scenarios for monetary policy (labeled A, B, and C)

  • The Teal Book:

    • Result of the 2010 merger of the Green and Blue books

  • The Beige Book:

    • Produced by Reserve Banks, detailing evidence from surveys and talks with key businesses and financial institutions about state of the economy in each Federal Reserve district

Central Bank Independence

  • Significance:

    • Objectives of a central bank require a long-term perspective insulated from political cycles (metaphor: "take the punch bowl away when the party gets going")

    • Elected officials often focus on short-term concerns that may influence their electability

  • Operational Components Supporting Independence:

    • The Fed controls its own budget free from political interference

    • Policies are not subject to review or reversal by other government entities

    • Fed officials have long-term appointments and cannot be removed during their term

Accountability and Transparency

  • Accountability:

    • Fed officials are appointed by elected officials (with the exception of regional Fed Presidents) but do not hold elected positions

    • Elected officials establish a set of goals: "The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."

    • This is laid out under the Full Employment and Growth Act (1978)

  • Transparency Initiatives:

    • FOMC now releases a variety of information to the public, a significant evolution from prior practices, which included very little information release about decisions before 1993

    • Current disclosures include:

    • The Beige Book

    • Policy decision announcements with explanatory statements

    • Detailed meeting minutes released 3 weeks after meetings

    • Word-for-word transcripts released 5 years later

    • Quarterly reports on economic growth and inflation projections

    • Monetary Policy Report to Congress twice a year

    • Chairs' appearances before Congress to discuss the economic state

    • Numerous speeches from the chair, governors, and Reserve Bank presidents, with press conferences following 4 monetary policy announcements

  • Historical Context of Target Ranges:

    • Prior to the 1990s, the Fed published target ranges for money supply growth (M1 and M2) as mandated by the Full Employment and Growth Act of 1978

    • These targets were rarely met and were phased out in the 1990s.

  • Interest Rate Changes:

    • Since 1994, the Fed has announced changes in the target federal funds rate (FFR) but did not explicitly provide statements about future interest rate policies.

    • Changes in the target FFR typically occur at a rate of 0.25 percentage points (i.e., 25 basis points) per meeting, with 8 regular meetings per year.

  • Shift in Communication Style:

    • Before 2009, the Fed communicated ambiguously about monetary policy direction (“Fedspeak”).

    • In 2009, the FOMC began issuing clearer guidance on policy objectives, aiming to enhance communication about future actions of the central bank.

    • An example of this guidance was the 2009 statement declaring, "…economic conditions warrant exceptionally low levels of the federal funds rate for an extended period."

    • In 2012, FOMC members established a de facto inflation target which evolved into an actual target thereafter.

Expansionary Monetary Policy

  • The expansionary policy involves lowering short-term interest rates during economic recessions.

  • Graphical Representation:

    • The Effective Federal Funds Rate fluctuates according to economic conditions, with key periods highlighting the effectiveness of policy changes in response to recessions, illustrated via the FRED (Federal Reserve Economic Data) graph.

Projections for Economic Factors

  • Real GDP Growth and Unemployment Rate:

    • The Fed's projections for real GDP growth and the unemployment rate focus on the years 2025-2027, presenting visuals on median projections, ranges, and actual outcomes over the years leading up to 2025.

  • Inflation Projections:

    • Includes projections for Core Personal Consumption Expenditures (PCE) inflation from 2020 through 2027, displaying current trends and expectations for future inflation.

  • Dot Plot of FOMC Participants:

    • Displays participants' assessments of appropriate monetary policy via the midpoint of target range or target level for the federal funds rate for the years 2025-2027.

    • Contains variations in expected target rates, reflecting the committee's collective economic outlook for both mid- and long-term timelines.