Tag: Structure of the Federal Reserve

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.

President Biden Decides to Reappoint Jerome Powell as Fed Chair

Jerome Powell (photo from the New York Times)

When Congress established the Federal Reserve System in 1913, it intended to make the Fed independent of the rest of the federal government. (We discuss this point in the opener to Macroeconomics, Chapter 15 and to Economics, Chapter 25. We discuss the structure of the Federal Reserve System in Macroeconomics, Chapter 14, Section 14.4 and in Economics, Chapter 24, Section 24.4.) The ultimate responsibility for operating the Fed lies with the Board of Governors in Washington, DC. Members of the Board of Governors are nominated by the president and confirmed by the Senate to 14-year nonrenewable terms. Congress intentionally made the terms of Board members longer than the eight years that a president serves (if the president is reelected to a second term).

The president is still able to influence the Board of Governors in two ways:

  1. The terms of members of the Board of Governors are staggered so that one term expires on January 31 of each even-number year. Although this approach means that it’s unlikely that a president will be able to appoint all seven members during the president’s time in office, in practice, many members do not serve their full 14-year terms. So, a president who serves two terms will typically have an opportunity to appoint more than four members of the Board.
  2. The president nominates one member of the Board to serve a renewable four-year term as chair, subject to confirmation by the Senate.

The terms of Fed chairs end in the year after the year a president begins either the president’s first or second term. As a result, presidents are often faced with what is at times a difficult decision as to whether to reappoint a Fed chair who was first appointed by a president of the other party.

For example, after taking office in January 2009, President Barack Obama, a Democrat, faced the decision of whether to nominate Fed Chair Ben Bernanke to a second term to begin in 2010. Bernanke had originally been appointed by President George W. Bush, a Republican. Partly because the economy was still suffering the aftereffects of the financial crisis and the Great Recession, President Obama decided that it would potentially be disruptive to financial markets to replace Bernanke, so he nominated him for a second term.

After taking office in January 2017, President Donald Trump, a Republican, had to decide whether to nominate Fed Chair Janet Yellen, who had been appointed by Obama, to another term that would begin in 2018. He decided not to reappoint Yellen and instead nominated Jerome Powell, who was already serving on the Board of Governors. Although a Republican, Powell had been appointed to the Board in 2014 by Obama.

President Biden’s reasons for nominating Powell to a second term to begin in 2022 were similar to Obama’s reasons for nominating Bernanke to a second term: The U.S. economy was still recovering from the effects of the Covid-19 pandemic, including the strains the pandemic had inflicted on the financial system. He believed that replacing Powell with another nominee would have been potentially disruptive to the financial system.

There had been speculation that Biden would choose Lael Brainard, who has served on the Board of Governors since 2014 following her appointment by Obama, to succeed Powell as Fed chair. Instead, Biden appointed Brainard as vice chair of the Board. In announcing the appointments, Biden stated: “America needs steady, independent, and effective leadership at the Federal Reserve. That’s why I will nominate Jerome Powell for a second term as Chair of the Board of Governors of the Federal Reserve System and Dr. Lael Brainard to serve as Vice Chair of the Board of Governors.”

Sources: Nick Timiraos and Andrew Restuccia, “Biden Will Tap Jerome Powell for New Term as Fed Chairman,” wsj.com, November 22, 2021; and Jeff Cox and Thomas Franck, “Biden Picks Jerome Powell to Lead the Fed for a Second Term as the U.S. Battles Covid and Inflation,” cnbc.com, November 22, 2021.