Chapter 12. Monetary Policy and Bank Regulation
12.1 The Federal Reserve Banking System and Central Banks
Learning Objectives
By the end of this section, you will be able to:
- Explain the structure and organization of the U.S. Federal Reserve
- Discuss how central banks impact monetary policy, promote financial stability, and provide banking services
In making decisions about the money supply, a central bank decides whether to raise or lower interest rates and, in this way, to influence macroeconomic policy, whose goal is low unemployment and low inflation. The central bank is also responsible for regulating all or part of the nation’s banking system to protect bank depositors and insure the health of the bank’s balance sheet.
We call the organization responsible for conducting monetary policy and ensuring that a nation’s financial system operates smoothly the central bank. Most nations have central banks or currency boards. Some prominent central banks around the world include the European Central Bank, the Bank of Japan, and the Bank of England. In the United States, we call the central bank the Federal Reserve—often abbreviated as just “the Fed.” This section explains the U.S. Federal Reserve‘s organization and identifies the major central bank’s responsibilities.
Structure/Organization of the Federal Reserve
Unlike most central banks, the Federal Reserve is semi-decentralized, mixing government appointees with representation from private-sector banks. At the national level, it is run by a Board of Governors, consisting of seven members appointed by the President of the United States and confirmed by the Senate. Appointments are for 14-year terms and they are arranged so that one term expires January 31 of every even-numbered year. The purpose of the long and staggered terms is to insulate the Board of Governors as much as possible from political pressure so that governors can make policy decisions based only on their economic merits. Additionally, except when filling an unfinished term, each member only serves one term, further insulating decision-making from politics. The Fed’s policy decisions do not require congressional approval, and the President cannot ask for a Federal Reserve Governor to resign as the President can with cabinet positions.
One member of the Board of Governors is designated as the Chair. For example, from 1987 until early 2006, the Chair was Alan Greenspan. From 2006 until 2014, Ben Bernanke held the post. United States Treasury Secretary Janet L. Yellen, was the first woman to serve as chair of the Federal Reserve. Janet Yellen holds a Ph.D. in economics from Yale University, prior to serving on the Federal Reserve Yellen taught macroeconomics at Harvard, the London School of Economics, and the University of California at Berkeley. In early 2018, Jerome Powell took over as Chair.
Who has the most immediate economic power in the world?
What individual can make financial market crash or soar just by making a public statement? It is not Bill Gates or Warren Buffett. It is not even the President of the United States. The answer is the Chair of the Federal Reserve Board of Governors. In early 2018, Jerome H. Powell became Chair of the Board of Governors of the Federal Reserve System. He was nominated for a second 4-year term beginning in 2022. Mr. Powell also serves at the Chairman of the Federal Open Market Committee which is in charge of making monetary policy decisions. He was first appointed to the Board of Governors in 2012 to fill an unexpired term. His 14 year appointment became official in 2014 and will end in 2028.
Prior to his appointment to the Board, Mr. Powell was a visiting scholar at the Bipartisan Policy Center in Washington, D.C., where he focused on federal and state fiscal issues. From 1997 through 2005, Mr. Powell was a partner at The Carlyle Group. Mr. Powell served as an Assistant Secretary and as Under Secretary of the U.S. Department of the Treasury under President George H.W. Bush, with responsibility for policy on financial institutions, the Treasury debt market, and related areas. Prior to joining the Bush administration, Mr. Powell worked as a lawyer and investment banker in New York City.
In addition to service on corporate boards, he has served on the boards of charitable and educational institutions, including the Bendheim Center for Finance at Princeton University and the Nature Conservancy of Washington, D.C., and Maryland. Mr. Powell was born in February 1953 in Washington, D.C. He received an Bachelor of Arts in politics from Princeton University in 1975 and earned a law degree from Georgetown University in 1979. While at Georgetown, he was editor-in-chief of the Georgetown Law Journal.
The Fed Chair is first among equals on the Board of Governors. While he or she has only one vote, the Chair controls the agenda, and is the Fed’s public voice, so he or she has more power and influence than one might expect.
Visit this website to see who the current members of the Federal Reserve Board of Governors are. You can follow the links provided for each board member to learn more about their backgrounds, experiences, and when their terms on the board will end. At the beginning of 2022 only 4 out of the 7 positions of the Board of Governors were filled due to delays in senate confirmation hearings.
The Federal Reserve is more than the Board of Governors. The Fed also includes 12 regional Federal Reserve banks, each of which is responsible for supporting the commercial banks and economy generally in its district. Figure 12.3 shows the Federal Reserve districts and the cities where their regional headquarters are located. The commercial banks in each district elect a Board of Directors for each regional Federal Reserve bank, and that board chooses a president for each regional Federal Reserve district. Thus, the Federal Reserve System includes both federally and private-sector appointed leaders.
What Does a Central Bank Do?
The Federal Reserve, like most central banks, is designed to perform three important functions:
- To conduct monetary policy
- To promote stability of the financial system
- To provide banking services to commercial banks and other depository institutions, and to provide banking services to the federal government.
The first two functions are sufficiently important that we will discuss them in their own modules. The third function we will discuss here.
The Federal Reserve provides many of the same services to banks as banks provide to their customers. For example, all commercial banks have an account at the Fed where they deposit reserves. Similarly, banks can obtain loans from the Fed through the “discount window” facility, which we will discuss in more detail later. The Fed is also responsible for check processing. When you write a check, for example, to buy groceries, the grocery store deposits the check in its bank account. Then, the grocery store’s bank returns the physical check (or an image of that actual check) to your bank, after which it transfers funds from your bank account to the grocery store’s account. The Fed is responsible for each of these actions.
On a more mundane level, the Federal Reserve ensures that enough currency and coins are circulating through the financial system to meet public demands. For example, each year the Fed increases the amount of currency available in banks around the Christmas shopping season and reduces it again in January.
Finally, the Fed is responsible for assuring that banks are in compliance with a wide variety of consumer protection laws. For example, banks are forbidden from discriminating on the basis of age, race, sex, or marital status. Banks are also required to disclose publicly information about the loans they make for buying houses and how they distribute the loans geographically, as well as by sex and race of the loan applicants.
Self-Check Question – answers found at end of chapter
- Why is it important for the members of the Board of Governors of the Federal Reserve to have longer terms in office than elected officials, like the President?
