Chapter 14: Structure of Central Banks and the Federal Reserve System

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Chapter 14 Structure of Central Banks and the
Federal Reserve System
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• 1. Formal Structure of the Federal Reserve
  System

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Formal Structure

• 12 District Banks
• Federal Advisory Council
• Board of Governors
• 7 members serve for 14 years
• Federal Open Market Committee
• 7 of 12 members come from board, the rest are
  district bank presidents
• Officially sets monetary policy

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• 2. Informal Structure of the Federal Reserve
  System

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Who Has Power?

• Original intent
• Board shares power with district banks
• Actual situation
• Board has nearly all the power because of the
  golden rule.
• Chair effectively controls the board for the
  following reasons
• Sets agenda of meetings
• Spokesperson for the board
• Bargains with Congress and President
• Supervises professional staff

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• 3. How Independent is the Fed?

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How Independent is the Fed?

• The Fed is quite independent from political
  pressure.
• Most important reason is its independent source
  of funds
• Chairs 4-year terms overlaps the Presidents.
• 14 year terms for Board of Governor Members.
• Constraints on the Fed
• Threat of more supervision by Congress or
  President
• Presidential appointments

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• 4. Explaining Central Bank Behavior

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Theory of Bureaucratic Behavior

• The theory of bureaucratic behavior states the
  objective of a bureaucracy is to maximize its own
  welfare (its own power and prestige).
• Examples consistent with the theory
• The Fed tries to avoid conflict with groups that
  may decrease its power
• The Fed tries to prevent increases in interest
  rates
• Invents strategies to avoid the blame for
  mistakes
• The Fed tries to increase its regulatory power
  over banks

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• 5. Should the Fed be Independent?

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Case for Independence

• An inflationary bias would result without
  independence
• Politicians focus on short-run goals not long-run
  goals.
• ? M ? ? i and ? y but ? p later
• U.S. political process leads to a political
  business cycle
• Politicians conduct expansionary policy before
  elections and contractionary policy later.
• Putting the Fed under the control of the
  president is dangerous.
• The president may increase the money supply to
  stop interest rate rises due to budget deficits.

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Case for Independence

• Politicians are not capable.
• Banking system reform, Social Security, and
  budget deficits.

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Case Against Independence

• It is undemocratic to have monetary policy under
  the control of an unaccountable group.
• Can't replace governors if they perform badly.
• Without coordination, fiscal and monetary policy
  may work in opposing directions.
• The Fed hasn't used its freedom successfully in
  the past.
• According to Friedman, the fed was "criminally
  inept" during the depression.
• Inflation in the 1960s and 1970s.

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EndChapter 14