Chapter 17 Who’s in Charge Here?

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

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

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

Organization Board of Governors 7 members Selection: Chairman of Board 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

Structure and Policy organization

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

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

Federal Reserve System

Structure Regional Banks 9 Directors President 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

Organization Legal authority of Fed Reserve Requirement 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

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

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

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

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?

Realities of the power within the Federal Reserve System.

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

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

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

Evolution of FED Power of the FOMC Role of member banks 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

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

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

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

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

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

Independence and Inflation