- Federal Reserve System
The central bank for the United States banking system and the institution that holds the primary responsibility for the making and execution of American monetary policies. Its bank notes circulate today as the United States' everyday paper currency. (Metal coins, however, are issued by the United States Treasury Department, not by the Federal Reserve.)
The Federal Reserve System represents an almost unique hybrid or blending of elements of governmental power with elements of private ownership and control. Because the authors of the 1913 legislation that set up the Federal Reserve System felt that it was vital to insulate monetary policy from "undue" pressure and influence by partisan politicians obsessed with their own short-range re-election prospects, the Federal Reserve was set up along the lines of an independent regulatory commission -- not as just one more agency of the Executive Branch that would be under the direction of the President and supervised closely by Congress. The private banking community was also given a major role in the running of the Federal Reserve System that continues to give banking interests privileged access to the process by which the US government's monetary policy is made.
The Federal Reserve System's highest decision-making body is its Board of Governors, which consists of seven members. Members of the Fed's Board of Governors are nominated for their positions by the President of the United States and then must be confirmed by a majority vote of the Senate before taking office. The members of the Federal Reserve's Board of Governors serve very long terms (fourteen years), and, once appointed and confirmed, they may not be removed from office by either President or Congress (except through a cumbersome process of impeachment by Congress for serious violations of the criminal law). People selected for appointment to the Board of Governors have nearly always been professional bankers, executives of Wall Street brokerage houses, or, occasionally, professional economists. They tend to share many of the relatively conservative political and economic views of the business and professional groups from which they are drawn. Because the President can not fire them from their positions before their fourteen-year terms expire, members of the Board of Governors normally feel relatively free to ignore or oppose the President's preferences when they make U.S. monetary policies. Moreover, even though some members of the Board of Governors perhaps feel an ideological kinship or sense of political loyalty that might predispose them to support the policy views of the President who appointed them, the terms of the Governors are staggered, so that only one Governor's term expires every two years, making it unlikely that any President would be able to dominate the Board with a majority of his own appointees until near the end of his own second four- year term in office. (However, every four years, the President does at least get the opportunity to designate which one of the seven Governors will serve for the next four years as Chairman of the Board of Governors and exercize "moral leadership" as first among equals in the Governors' collective deliberations on monetary policy.)
Congressional influence on the Federal Reserve System's monetary policy decisions is also in practice rather limited. The Federal Reserve generates its own revenues to pay its expenses from fees paid to it by the commercial banks it regulates and from interest payments on the federal bonds, notes and bills that it holds as assets, so Congress lacks the normal leverage it has over other agencies through carrots and sticks brandished during the annual appropriations process. Of course, Congress, which created the Federal Reserve System by statute in 1913, has the constitutional power to alter or abolish the Federal Reserve system by a simple majority vote in both houses, subject to the possibility of a presidential veto, and the threat that Congress might actually do so if the Fed's policies contradict Congresssional preferences too seriously for too long undoubtedly induces a certain amount of responsiveness to Congressional jaw-boning by the Fed's policy-makers.
The Federal Reserve System presided over by the Board of Governors consists organizationally of 12 separate Federal Reserve District Banks -- each one located in and serving one of twelve geographical regions of the country. The district Federal Reserve banks are organized rather like private banking corporations whose shareholders consist of the private member banks in the district. But despite their semi-private character, the district Federal Reserve banks exercise Congressionally delegated legal powers to regulate the banking industry. Each district Federal Reserve Bank is managed from day to day by its own president, who is elected to a 5-year term by his district Federal Reserve Bank's own individual board of directors. Two-thirds of the members of the district boards of directors are elected to their positions by the privately owned commercial banks in the district that are member banks of the Federal Reserve system. (Member banks are divided on the basis of their assets into "small", "medium", and "large" banks, with each category of banks allowed to elect two directors on a "one bank, one vote" basis.) The other one- third of the directors in each district are appointed from Washington by the Fed's Board of Governors, rather as though the Board of Governers were a major creditor or minority stockholder with guaranteed representation on the district boards.
The district Federal Reserve Banks act as non-profit "bankers' banks" -- that is, only commercial banking or depository institutions (and certain agencies of the federal government) maintain deposits at the Federal Reserve, and only member banking institutions and the US government are eligible to receive loans from it, not private citizens nor other kinds of non-bank commercial enterprises. All banks chartered as "national banks" by Federal law must be "member banks," that as such are obligated to maintain most of their reserves as deposits in their accounts at the Federal Reserve and to submit to detailed Federal Reserve banking regulations. Many state-chartered banks and thrift institutions nowadays also choose to be members of the Federal Reserve System and submit to its regulations in order to enjoy the valuable services which the Fed provides to them.
The district Federal Reserve Banks operate clearing houses for checks and bank drafts, issue new paper currency ("Federal Reserve notes") for sale to member banks on demand, withdraw worn-out currency from circulation, sit in judgment on the applications of banks that wish permission to merge with each other, extend "discount loans" to member banks (with the member banks putting up their own borrowers IOUs as collateral), and perform various miscellaneous regulatory functions pertaining to the banks in their districts. When the Federal Reserve System was originally created back in 1913, it was expected that the district Federal Reserve Banks would each pursue slightly different monetary policies, depending upon the economic conditions in their individual districts, so they were given the authority to collect a wide variety of information and statistical data on changes in regional business conditions to use in their decision-making. The high degree of integration of the national economy has for many years made it impractical for the district Federal Reserve Banks to maintain different levels of interest rates or pursue differing policies regarding the growth or contraction of the money stock (these policy decisions are made centrally for the entire country by the Fed's Board of Governors in consultation with the district bank presidents), but the 12 district banks are still a major source of detailed economic data used by government policy-makers at both the national, state and local levels as well as by private economic forecasters and business executives.
The primary reason why the banking industry generally supported the creation of the Federal Reserve System and continues to support it today despite the inconveniences imposed by the Fed's regulations, is the valuable privilege that memberhip brings to the bankers to count on the Fed for large emergency loans of cash if they someday need it to survive a "run" on their bank. In a bank "run," large numbers of depositors frightened by rumors that their bank is about to fail suddenly begin crowding into the bank, demanding to withdraw all their deposits in cash. This exhausts the very limited cash reserves normally kept on hand in the bank's own vaults within a few hours. Since the large majority of the depositers' dollars on deposit are always out on loan to the bank's credit customers, and since it takes days or weeks to call in any sizable fraction of the loans outstanding, the bank would have to "go bankrupt" and be liquidated by the courts unless it can raise enough cash somewhere on short notice to pay off the panicky depositers demanding their money. This is where the Fed steps in as rescuing angel with armored cars full of cash pulling up to the beleagered bank within a few hours.
Bank runs are much more rare nowadays than they used to be, mainly because most depositers today feel much less reason to panic when they believe that they can get their money "for sure" -- either by virtue of the Fed's stepping in with loans in the case of a short-term "liquidity crunch" if the bank in question is relatively sound or (with more delay) by virtue of the insurance provided by the Federal Deposit Insurance Corporation if the bank really does turn out to be irretrievably in the red financially. And because runs are now both less likely to happen and less dangerous to the bank even if they do, bankers can earn higher profits by maintaining lower reserves than would otherwise be necessary and thus being able to lend out a higher percentage of their deposits at interest.
Because many bankers with the "king's X" of Federal Reserve and FDIC backing if they should get into difficulties might otherwise pursue excessively reckless lending policies to increase their profits, the Federal Reserve's Board of Governors was given the power to set minimum reserve requirements for the member banks, to make regulations limiting the riskiness of banks' loan portfolios, and to send "bank examiners" out periodically to audit the books of member banks in order both to assure their compliance with regulations and to safeguard depositors' accounts against fraud or embezzlement by bank managers and employees.
The Fed's role as maker and executer of macroeconomically significant monetary policies for the United States government centers around three major policy tools at the Fed's disposal:
Manipulating the legally required reserve ratios ("reserve requirements") for banks (and, less directly, for some other depository institutions, such as savings and loans and credit unions)
Buying or selling U.S. government debt instruments (Treasury bonds, notes and bills) on the private financial markets in New York ("open market operations")
Setting the interest rate at which the Fed stands ready to make short-term loans to member banks and other depository institutions that would othertwise fall below the required reserve ratios (the Fed's "discount rate").
Using its discretionary power to manipulate these policy tools, the Fed is able to exercise substantial influence (but not complete control) over changes in the size of the money stock and thus over interest rates, thereby influencing overall levels of business activity and employment in the national economy (as well as indirectly influencing the rates at which the dollar is exchanged for foreign currencies and thus the flow of international trade and investment across U.S. borders).
The Fed's Board of Governors sets policies regarding reserve requirements and the discount rate all by itself, but changes in these two policy levers tend to be relatively infrequent (perhaps once or twice a year on average for the discount rate, and perhaps once every five to ten years on average for the reserve requirement). The Fed's main policy tool of choice for exerting its influence on the money stock and interest rates on a week-to-week basis is its "open market operations." The necessary policy decisions about the Fed's on-going open market operations (buying or selling varying quantities of U.S. bonds and other treasury securities on the New York financial markets) are made for the Fed's Board of Governors by a slightly expanded body called the Federal Open Market Committee (FOMC). The FOMC consists of all seven members of the Board of Governors plus five of the 12 banker-elected presidents of the Federal Reserve district banks. (The president of the New York district bank is a permanent member of the FOMC, while the other 11 district bank presidents serve one-year terms on a rotating basis, with only four of them having the right to vote at any given time.) The FOMC meets rather frequently in Washington, DC, but it has also been the practice in recent years for the FOMC membership to convene informally via long-distance telephone conference calls or one-on-one communications with the Fed's Chairman on almost a daily basis.