The Federal Reserve (1913)

• Original Roles

-- Provider of Discount Window --

“Lender of Last Resort”

-- Regulate Member Banks

(e.g. Reserve Ratios)

• Manages Monetary Policy

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Structure of the Federal Reserve

Board of Governors (BOG)

• 7 members
• appointed by the President, with the consent of the Senate
• serve 14 year, non-renewable terms
• sets policy instruments other than open market operations
• decides permissible activities of banks and holding companies

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• Important Chairs of the BOG (Federal Reserve)

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• Paul Volcker -- 1979-87
• Alan Greenspan -- 1987-2006
• Ben Bernanke – 2006-

The Federal Open Market Committee (FOMC)

• 12 voting members -- 7 Board of Governors + 5 District Bank Presidents (19 members in all)
• meet 8 times per year (more, if needed)
• design monetary policy, by specifying Federal Funds rate target (since 1988)

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Federal Reserve District Banks

• each bank exists within 12 districts within the US
• holds deposits of Federal Government
• collects economic data and does economic research
• issues and discards currency
• performs check clearing services

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District Banks -- Administer Monetary Policy

• conduct Discount Loans with banks within district
• enforce reserve requirements for banks within district
• hold reserves of banks within district
• New York bank most important, open market operations done there

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Federal Reserve Branch Banks and Member Banks

• Branch (District) Banks -- serve as decentralized regulators, primarily for larger Fed districts in geographic size
• Private Banks -- membership distinction trivialized by DIDMCA

How Independent is The Federal Reserve?

• Structure implies considerable independence.
• Federal Reserve is financially independent of the Federal Government’s budget.

• Federal Reserve is still subject to Congressional legislation.

-- House Concurrent Resolution

133 -- Fed must announce its

policy objectives for money

growth.

-- Humphrey-Hawkins Bill -- Fed

must testify to Congress how its

objectives are consistent with

the President.

• The President and the Federal Reserve

-- President appoints members of

the BOG

-- BOG typically serve less than 14

year terms

-- part of the legislative process,

can introduce legislation

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• Federal Reserve has vigorous lobby in Congress.

-- banks: stability of banking

system

-- financial markets: low inflation,

stability

-- international presence

Explaining Federal Reserve Behavior

• Theory of Bureaucratic Behavior -- The objective of a bureaucracy is to maximize its own welfare.

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• Applied to the Federal Reserve -- The Fed seeks to maximize its power and autonomy.

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Evidence: The Fed and The Theory of Bureaucratic Behavior

• Fed avoids conflict with Congress.
• Fed does not admit policy mistakes (e.g. “Base Drift)
• Fed supports legislation that increases its authority (FDIC)
• Fed has not seen any of its powers removed.

Should the Federal Reserve Remain Independent?

Arguments to Remove Independence

• Current Federal Reserve is not democratic, not accountable.
• Fed has made policy mistakes.
• Potential for uncoordinated fiscal and monetary policies
• Example -- expansionary fiscal policy with contractionary monetary policy ⇒ Interest rates↑

Arguments to Maintain Independence

• If part of the Federal Government, the Federal Reserve could be used to purchase all of the Federal deficit and debt (“monetizing the debt), highly inflationary.
• Federal Reserve is more knowledgeable and focused on the economy than Congress.

The Biggest Argument For Continued Independence

• Current Federal Reserve can make the tough policy decisions.

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• The track record of the US Federal Reserve: the Volcker and Greenspan years.