Tag: Federal Reserve Act

Does the Structure of the Fed Matter?

Photo of the Federal Reserve Bank of Dallas from federalreservehistory.org.

The unusual structure of the Federal Reserve System reflects the political situation at the time that Congress passed the Federal Reserve Act in 1913. As we discuss in Money, Banking, and the Financial System, Chapter 13, at that time, many members of Congress believed that a unified central bank based in Washington, DC would concentrate too much economic power in the hands of the officials running the bank. So, the act divided economic power within the Federal Reserve System in three ways: among bankers and business interests, among states and regions, and between the federal government and the private sector.

As part of its plan to divide authority within the Federal Reserve System, Congress decided not to establish a single central bank with branches, which had been the structure of both the First and Second Banks of the United States—which were the two attempts by Congress during the period from 1791 to 1836 to establish a central bank. Instead, the Federal Reserve Act divided the United States into 12 Federal Reserve districts, each of which has a Federal Reserve Bank in one city (and, in most cases, additional branches in other cities in the district). The following figure is the original map drawn by the Federal Reserve Organizing Committee in 1913 showing the 12 Federal Reserve Districts. Congress adopted the map with a few changes, following which the areas of the 12 districts have remained largely unchanged down to the present.

The map is from federalreservehistory.org.

The following map shows the current boundaries of the Federal Reserve Districts.

The map is reproduced from the working paper discussed below.

All national banks—commercial banks with charters from the federal government—were required to join the Federal Reserve System. State banks—commercial banks with charters from state governments—were given the option to join. Congress intended that the primary function of each of the Federal Reserve Banks would be to make discount loans to member banks in its region. These loans were to provide liquidity to banks, thereby fulfilling in a decentralized way the system’s role as a lender of last resort.

When banks join the Federal Reserve System, they are required to buy stock in their Federal Reserve Bank, which pays member banks a dividend on this stock. So, in principle, the private commercial banks in each district that are members of the Federal Reserve System own the District Bank. In fact, each Federal Reserve Bank is a private–government joint venture because the member banks enjoy few of the rights and privileges that shareholders ordinarily exercise. For example, member banks do not have a legal claim on the profits of the District Banks, as shareholders of private corporations do.

On paper, the Federal Reserve System is a decentralized organization with a public-private structure. In practice, power within the system is concentrated in the seven member Board of Governors in Washington, DC. Control over the most important aspect of monetary policy—setting the target for the federal funds rate—is vested in the Federal Open Market Committee (FOMC). The voting membership of the FOMC consists of the seven member of the Board of Governors, the president of the Federal Reserve Bank of New York and four other district bank presidents on a rotating basis (although all 12 district presidents participate in committee discussions). The district bank presidents are elected by the boards of directors of the district banks, but the Board of Governors has final say on who is chosen as a district bank president.

Given these considerations, does the structure of the Fed matter or is it an unimportant historical curiosity? There are reasons to think the Fed’s structure does still matter. First, as we discuss in this blog post, in a recent decision, the U.S. Supreme Court implied—but didn’t state explicitly—that, because of the Fed’s structure, U.S. presidents will likely not be allowed to remove Fed chairs except for cause. That is, if presidents disagree with monetary policy actions, they will not be able to remove Fed chairs on that basis.

Second, as Michael Bordo of Rutgers University and the late Nobel Laureate Edward Prescott argue, the decentralized structure of the Fed has helped increase the variety of policy views that are discussed within the system:

“What is unique about the Federal Reserve, at least compared with other
entities created by the federal government, is that the Reserve Banks’
semi-independent corporate structure allows for ideas to be communicated to
the System . . . . Moreover, it also allows for new and sometimes dissenting views to develop and gestate within the System without being viewed as an expression of disloyalty that undermines the organization as a whole, as would be more likely within a government bureau.”

Finally, recent research by Anton Bobrov of the University of Michigan, Rupal Kamdar of Indiana University, and Mauricio Ulate of the Federal Reserve Bank of San Francisco indicates that the FOMC votes of the district bank presidents reflect economic conditions in those districts. This result indicates that the district bank presidents arrive at independent judgements about monetary policy rather than just reflecting the views of the Board of Governors, which has to approve the appointment of the presidents. The authors analyze the 896 dissenting votes district bank presidents (other than the president of the NY Fed) cast during the period from 1990 to 2017. A dissenting vote is one in which the district bank president voted to either increase or decrease the target for the federal funds relative to the target the majority of the committee favored.

The authors’ key finding is that the FOMC votes of district bank presidents are influenced by the level of unemployment in the district: “a 1 percentage point higher District unemployment rate increases the likelihood that the respective District president will dissent in favor of looser policy [that is, a lower federal funds rate target than the majority of the committee preferred] at the FOMC by around 9 percentage points.” The authors note that: “The influence of local economic conditions on dissents by District presidents reflects the regional structure of the Federal Reserve System, which was designed to accommodate diverse views across the nation.” (The full text of the paper can be found here. A summary of the paper’s findings by Ulate and Caroline Paulson and Aditi Poduri of the San Francisco Fed can be found here.)

The Supreme Court Seems Unlikely to Allow Presidents to Fire Fed Chairs

Photo of Federal Reserve Chair Jerome Powell from federalreserve.gov

Can a president fire the chair of the Federal Reserve in the same way that presidents have been able to fire cabinet secretaries? President Donald Trump has had a contentious relationship with Fed Chair Jerome Powell. Powell’s term as Fed chair is scheduled to end in May 2026. At times, Trump has indicated that he would like to remove Powell before Powell’s term ends, although most recently he’s indicated that he won’t do so.

Does Trump, or any president, have the legal authority to replace a Fed chair before the chair’s term expires? As we discuss in Macroeconomics, Chapter 27 (Economics Chapter 17), according to the Federal Reserve Act, once a Fed chair is nominated to a four-year term by the president (President Trump first nominated Powell to be chair in 2017 and Powell took office in 2018) and confirmed by the Senate, the president cannot remove the Fed chair except “for cause.” As we’ve noted in previous blog posts, most legal scholars argue that a president cannot remove a Fed chair due to a disagreement over monetary policy.

But if the Fed is part of the executive branch of the federal government and the president is the head of executive branch, why shouldn’t the president be able to replace a Fed chair. Article I, Section II of the Constitution of the United States states that: “The executive Power shall be vested in a President of the United States of America.” The ability of Congress to limit the president’s power to appoint and remove heads of commissions, agencies, and other bodies in the executive branch of government—such as the Federal Reserve—is not clearly specified in the Constitution. In 1935, a unanimous Supreme Court ruled in the case of Humphrey’s Executor v. United States that President Franklin Roosevelt couldn’t remove a member of the Federal Trade Commission (FTC) because in creating the FTC, Congress specified that members could only be removed for cause. Legal scholars have presumed that the ruling in this case would also bar attempts by a president to remove members of the Fed’s Board of Governors because of a disagreement over monetary policy.

Earlier this year, the Trump administration fired a member of the National Labor Relations Board (NLRB) and a member of the Merit Systems Protection Board (MSPB). The members sued and an appeals court ordered the president to reinstate the members. The Trump administration appealed the order to the Supreme Court, which on Thursday (May 22) granted a stay of the order on the grounds that “the Government is likely to show that both the NLRB and MSPB exercise considerable executive power,” and therefore can be removed by the president, when the case is heard by the lower court. The ruling indicated that a majority of the Supreme Court is likely to overturn the Humphrey’s Executor precedent either in this case, if it ends up being argued before the court, or in a similar case. (The Supreme Court’s order is here. An Associated Press article describing the decision is here. An article in the Wall Street Journal discussing the issues involved is here.)

Does the Supreme Court’s ruling in this case indicate that it would allow a president to remove a Fed chair? The court explicitly addressed this question, first noting that attorneys for the two board members had argued that “arguments in this case necessarily implicate the constitutionality of for-cause removal protections for members of the Federal Reserve’s Board of Governors or other members of the Federal Open Market Committee.” But the majority of the court didn’t accept the attorneys’ argument: “We disagree. The Federal Reserve is a uniquely structured, quasi-private entity that follows in the distinct historical tradition of the First and Second Banks of the United States.” (We discuss the First and Second Banks of the United States in Money, Banking, and the Financial System, Chapter 10.)

We discuss the unusual nature of the Fed’s structure in Macroeconomics, Chapter 14, Section 14.4, where we note that Congress gave the Fed a hybrid public-private structure and the ability to fund its own operations without needing appropriations from Congress. Fed Chair Powell clearly agrees that the Fed’s structure distinguishes its situation from that of other federal boards and commissions. Responding to a question following a speech in April, Powell indicated that he believes that the Fed’s unique structure means that a president would not have the power to remove a Fed chair.

It’s worth noting that the statement the court issued had the limited scope of staying the appeals court’s ruling that the members of the two commissions be reinstated. If a case arises that addresses directly the question of whether presidents can remove Fed chairs, it’s possible that, after hearing oral and written arguments, some of the justices may change their minds and decide that the president has that power. It wouldn’t be unusual for justices to change their minds during the process of deciding a case. But for now it appears that the Supreme Court would likely not allow a president to remove a Fed chair.

Yesterday at the Fed Something Happened That Was Unusual … or Was It?

Photo of Michael Barr from federalreserve.gov

President-elect Donald Trump has stated that he believes that presidents should have more say in monetary policy. There had been some speculation that once in office Trump would try to replace Federal Reserve Chair Jerome Powell, although Trump later indicated that he would not attempt to replace Powell until Powell’s term as chair ends in May 2026. Can the president remove the Fed Chair or another member of the Board of Governors? The relevant section of the Federal Reserve Act States that: “each member [of the Board of Governors] shall hold office for a term of fourteen years from the expiration of the term of his predecessor, unless sooner removed for cause by the President.”

“Removed for cause” has generally been interpreted by lawyers inside and outside of the Fed as not authorizing the president to remove a member of the Board of Governors because of a disagreement over monetary policy. The following flat statement appears on a page of the web site of the Federal Reserve Bank of St. Louis: “Federal Reserve officials cannot be fired simply because the president or a member of Congress disagrees with Federal Reserve decisions about interest rates.”

At his press conference following the November 7 meeting of the Federal Open Market Committee (FOMC), Powell was asked by a reporter: “do you believe the President has the power to fire or demote you, and has the Fed determined the legality of a President demoting at will any of the other Governors with leadership positions?” Powell replied: “Not permitted under the law.” Despite Powell’s definitive statement, because no president has attempted to remove a member of the Board of Governors, the federal courts have never been asked to decide what the “removed for cause” language in the Federal Reserve Act means.

The president is free to remove the members of most agencies of the federal government, so why shouldn’t he or she be able to remove the Fed Chair? When Congress passed the Federal Reserve Act in 1913, it intended the central bank to be able set policy independently of the president and Congress. The president and members of Congress may take a short-term view of policy, focusing on conditions at the time that they run for reelection. Expansionary monetary policies can temporarily boost employment and output in the short run, but cause inflation to increase in the long run.

As we discuss in Macroeconomics, Chapter 17, Section 17.4 (Economics, Chapter 27, Section 27.4), in a classic study, Alberto Alesina and Lawrence Summers compared the degree of central bank independence and the inflation rate for 16 high-income countries during the years from 1955 to 1988. As the following figure shows, countries with highly independent central banks, such as the United States, Switzerland, and Germany, had lower inflation rates than countries whose central banks had little independence, such as New Zealand, Italy, and Spain.

Yesterday, something unusual happened that might seem to undermine Fed independence. Michael Barr, a member of the Board of Governors and the Board’s Vice Chair for Supervision, said that on February 28 he will step down from his position as Vice Chair, but will remain on the Board. His term as Vice Chair was scheduled to end in July 2026. His term on the Board is scheduled to end in January 2032.

Barr has been an advocate for stricter regulation of banks, including higher capital requirements for large banks. These positions have come in for criticism from banks, from some policymakers, and from advisers to Trump. Barr stated that he was stepping down because: “The risk of a dispute over the position could be a distraction from our mission. In the current environment, I’ve determined that I would be more effective in serving the American people from my role as governor.” Trump will nominate someone to assume the position of vice chair, but because there are no openings on the Board of Governors he will have to choose from among the current members.

Does this episode indicate that Fed independence is eroding? Not necessarily because the Fed’s regulatory role is distinct from its monetary policy role. As financial journalist Neil Irwin points out, “top [Fed] bank supervision officials view their role as more explicitly carrying out the regulatory agenda of the president who appointed them—and that a new president is entitled, in reasonable time, to their own choices.” In the past, other members of the Board who have held positions similar to the one Barr holds have resigned following the election of a new president.

So, it’s unclear at this point whether Barr’s resignation as vice chair indicates that the incoming Trump Administration will be taking steps to influence the Fed’s monetary policy actions or how the Fed’s leadership will react if it does.

Will the Fed Not Cut Rates at All this Year?

Federal Reserve Vice Chair Philip Jefferson (photo from the Federal Reserve)

Federal Reserve Chair Jerome Powell (photo from the Federal Reserve)

At the beginning of 2024, investors were expecting that during the year the Fed’s policy-making Federal Open Market Committee (FOMC) would cut its target range for the federal funds rate six or seven times. At its meeting on March 19-20 the economic projections of the members of the FOMC indicated that they were expecting to cut the target range three times from its current 5.25 percent to 5.50 percent. But, as we noted in this recent post and in this podcast, macroeconomic data during the first three months of this year indicated that the U.S. economy was growing more rapidly than the Fed had expected and the reductions in inflation that occurred during the second half of 2023 had not persisted into the beginning of 2024.

The unexpected strength of the economy and the persistence of inflation above the Fed’s 2 percent target have raised the issue of whether the FOMC will cut its target range for the federal funds rate at all this year. Earlier this month, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis raised the possibility that the FOMC would not cut its target range this year.

Today (April 16) both Fed Vice Chair Philip Jefferson and Fed Chair Jerome Powell addressed the issue of monetary policy. They gave what appeared to be somewhat different signals about the likely path of the federal funds target during the remainder of this year—bearing in mind that Fed officials never commit to any specific policy when making a speech. Adressing the International Research Forum on Monetary Policy, Vice Chair Jefferson stated that:

“My baseline outlook continues to be that inflation will decline further, with the policy rate held steady at its current level, and that the labor market will remain strong, with labor demand and supply continuing to rebalance. Of course, the outlook is still quite uncertain, and if incoming data suggest that inflation is more persistent than I currently expect it to be, it will be appropriate to hold in place the current restrictive stance of policy for longer.”

One interpretation of his point here is that he is still expecting that the FOMC will cut its target for the federal funds rate sometime this year unless inflation remains persistently higher than the Fed’s target—which he doesn’t expect.

Chair Powell, speaking at a panel discussion at the Wilson Center in Washington, D.C., seemed to indicate that he believed it was less likely that the FOMC would reduce its federal funds rate target in the near future. The Wall Street Journal summarized his remarks this way:

“Federal Reserve Chair Jerome Powell said firm inflation during the first quarter had introduced new uncertainty over whether the central bank would be able to lower interest rates this year without signs of an economic slowdown. His remarks indicated a clear shift in the Fed’s outlook following a third consecutive month of stronger-than-anticipated inflation readings ….”

An article on bloomberg.com had a similar interpretation of Powell’s remarks: “Federal Reserve Chair Jerome Powell signaled policymakers will wait longer than previously anticipated to cut interest rates following a series of surprisingly high inflation readings.”

Politics may also play a role in the FOMC’s decisions. As we discuss in Macroeconomics, Chapter 17, Section 17.4 (Economics, Chapter 27, Section 27.4), the Federal Reserve Act, which Congress passed in 1913 and has amended several times since, puts the Federal Reserve in an unusal position in the federal government. Although the members of the Board of Governors are appointed by the president and confirmed by the Senate, the Fed was intended to act independently of Congress and the president. Over the years, Fed Chairs have protected that independence by, for the most part, avoiding taking actions beyond the narrow responsibilites Congress has given to the Fed by Congress and by avoiding actions that could be interpreted as political.

This year is, of course, a presidential election year. The following table from the Fed’s web site lists the FOMC meetings this year. The presidential election will occur on November 5. There are four scheduled FOMC meetings before then. Given that inflation has been running well above the Fed’s target during the first three months of the year, it would likely take at least two months of lower inflation data—or a weakening of the economy as indicated by a rising unemployment rate—before the FOMC would consider lowering its federal funds rate target. If so, the meeting on July 30-31 might be the first meeting at which a rate reduction would occur. If the FOMC doesn’t act at its July meeting, it might be reluctant to cut its target at the September 17-18 meeting because acting close to the election might be interpreted as an attempt to aid President Joe Biden’s reelection.

Although we don’t know whether avoiding the appearance of intervening in politics is an important consideration for the members of the FOMC, some discussion in the business press raises the possibility. For instance, a recent article in the Wall Street Journal noted that:

“The longer that officials wait, the less likely there will be cuts this year, some analysts said. That is because officials will likely resist starting to lower rates in the midst of this year’s presidential election campaign to avoid political entanglements.”

These are clearly not the easiest times to be a Fed policymaker!

Is the Fed Becoming Too Political to Remain Independent?

Neel Kashkari, president of the Federal Reserve Bank of Minneapolis. Photo from the Wall Street Journal.
Pat Toomey, U.S. Senator from Pennsylvania. Photo from http://www.toomey.senate.gov.

As we discuss in Macroeconomics, Chapter 17, Section 17.4 (Economics, Chapter 27, Section 27.4), the Federal Reserve is unusual among federal government agencies in being able to operate largely independently of Congress and the president.  Congress passed the Federal Reserve Act, which established the Federal Reserve System, in 1913, and has amended it several times in the years since. (Note that, as we discuss in the Apply the Concept, “End the Fed?” in this chapter, the U.S. Constitution does not explicitly authorized the federal government to establish a central bank.) Section 2A of the act gives the Federal Reserve System the following charge:

“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

Elsewhere in the act, the Fed was given other specified responsibilities, such as supervising commercial banks that are members of the Federal Reserve System and serving on the Financial Stability Oversight Council (FSOC), which is charged with assessing risks to the financial system. 

Because Congress can change the structure and operations of the Fed at any time and because Congress has given the Fed only certain specific responsibilities, traditionally the Fed has avoided becoming involved in policy debates that are not directly concerned with its responsibilities. Over the years, most members of the Board of Governors have believed that if the Fed were to become involved in issues beyond monetary policy and the working of the financial system, Congress might decide to revise the Federal Reserve Act to reduce, or even eliminate, Fed independence.

In the spring of 2022, though, there were two instances where some members of Congress argued that the Fed had become involved in policy issues that went beyond the Fed’s responsibilities under the Federal Reserve Act. The first instance involved President Joe Biden’s nomination in January 2022 of Sarah Bloom Raskin to serve on the Fed’s Board of Governors. In 2010, Raskin was nominated to the Board of Governors by President Barack Obama and confirmed by the Senate in a voice vote without significant opposition. (In 2014, she resigned from the Board to accept a position in the Treasury Department.)

Her nomination by President Biden encountered significant opposition, however, largely because in July 2020 she had suggested that when the Fed expanded its lending programs during the Covid-19 pandemic it should have excluded firms in the oil, natural gas, and coal industries: “The Fed is ignoring clear warning signs about the economic repercussions of the impending climate crisis by taking action that will lead to increases in greenhouse gas emissions at a time when even in the short term, fossil fuels are a terrible investment.” Although her supporters argued that in formulating policy the Fed should take into account the threats to financial stability caused by climate change, when it became clear that a majority of the Senate disagreed, Raskin withdrew her nomination. 

In April 2022, some members of Congress, including Senator Pat Toomey of Pennsylvania, questioned whether it was appropriate for President Neel Kashkari of the Federal Reserve Bank of Minneapolis to formally support the campaign to amend the Minnesota state constitution to include a provision stating that, “All children have a fundamental right to a quality public education …. It is a paramount duty of the state to ensure quality public schools that fulfill this fundamental right.”

The Bank defended its support for the amendment in a statement on its website: “The Federal Reserve Bank of Minneapolis’ support of the Page amendment is closely linked to the mission of the Federal Reserve. Congress assigned the Federal Reserve the dual goals of achieving (1) stable prices and (2) maximum employment, and one of the greatest determinants of success in the job market is education.”

Senator Toomey strongly disagreed, arguing in a letter of Bank President Kashkari that: “This amendment is highly political, as it wades into an ongoing debate about whether government-run school systems are preferable to parental choice in education.” Toomey asserted that: “These political lobbying efforts by you and other Minneapolis Fed officials … are well beyond the Federal Reserve’s mandate, violate Federal Reserve Bank policies, constitute a misuse of Minneapolis Fed resources, and ultimately undermine the Federal Reserve’s independence and credibility.”

It remains to be seen whether Congress will ultimately accept the arguments of Federal Reserve policymakers such as Kashkari and Raskin that the Fed needs to interpret its mandate from Congress more broadly, or whether Congress will decide to amend the Federal Reserve Act to more explicitly limit the boundaries of Fed action—or to reduce Fed independence in some other ways. 

Sources: Sarah Bloom Raskin, “Why Is the Fed Spending So Much Money on a Dying Industry?” New York Times, May 28, 2020; Andrew Ackerman and Ken Thomas, “Sarah Bloom Raskin Withdraws as Biden’s Pick for Top Fed Banking Regulator,” Wall Street Journal, March 15, 2022; Michael S. Derby, “GOP Senator Criticizes Minneapolis Fed Over Education Issue,” Wall Street Journal, April 12, 2022; Federal Reserve Bank of Minneapolis, “Page Amendment: Every Child Deserves a Quality Public Education,” minneapolisfed.org; and Pat Toomey, “Letter to Neel Kashkari,” banking.senate. gov, April 11, 2022.