Chapter 16.

Structure of Central
Banks & the Federal Reserve
System

• Origins
• Structure
• Comparison to ECB
Origins
• “the Fed”
• Federal Reserve Act 1913
 response to panic of 1907
• obstacles
 fear of centralized power
• solution
 decentralized structure
Structure
• 3 main parts:
 Federal Reserve Banks
 Board of Governors
 FOMC
Federal Reserve Banks

• 12 regional banks
• serve the member banks in that
district
-- all national banks
-- option for state banks
-- 33% of commercial banks
• 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 bank
1980 DIDMCA

• all depository institutions

 keep reserves on deposit at district
bank
 have access to discount loans
Board of Governors

• 7 governors
 14-yr. terms (nonrenewable)
 1 chair
-- 4-year renewable term
-- Alan Greenspan (1987-2006)
-- Ben Bernanke (2006-
• 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
 Consumer protections
 stock margin requirements
 final say in bank mergers
FOMC

• Federal Open Market Committee

• 12 members
 7 governors
 FRBNY President
 4 other district bank presidents
rotate
• 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
Fed structure & reality

• appears decentralized
• but power concentrated w/
 Board of governors
 Chair
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
sources of independence

• 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
Fed independence is not
complete!
• Congress has ultimate power to limit
or eliminate Fed
• chairman testifies before Congress
every 6 months
Is independence good?

• common in industrialized countries

• but it is undemocratic
Pros
• 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 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
Cons

• 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
ECB: a comparison

• European Central Bank

 1999
 Central bank for monetary policy
of 12 euro countries
 A larger economy than U.S.
ECB structure

• Executive board
 like Board of Gov
• National Central Banks (NCB)
 Like Federal Reserve Banks
• Governing Council
 Like FOMC
Key differences

• ECB does NOT regulate financial

institutions
• ECB gets budget from NCB
• No voting on the Governing Council
• VERY independent
 Countries cannot change ECB
decisions