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Structure of the Fed

25 April, 2016 - 09:12

In creating the Fed, Congress determined that a central bank should be as independent of the government as possible. It also sought to avoid too much centralization of power in a single institution. These potentially contradictory goals of independence and decentralized power are evident in the Fed’s structure and in the continuing struggles between Congress and the Fed over possible changes in that structure.

In an effort to decentralize power, Congress designed the Fed as a system of 12 regional banks, as shown in Figure 24.2. Each of these banks operates as a kind of bankers’ cooperative; the regional banks are owned by the commercial banks in their districts that have chosen to be members of the Fed.The owners of each Federal Reserve bank select the board of directors of that bank; the board selects the bank’s president.

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Figure 24.2 The 12 Federal Reserve Districts and the Cities Where Each Bank Is Located

Several provisions of the Federal Reserve Act seek to maintain the Fed’s independence. The board of directors for the entire Federal Reserve System is called the Board of Governors. The seven members of the board are appointed by the president of the United States and confirmed by the Senate. To ensure a large measure of independence from any one president, the members of the Board of Governors have 14-year terms. One member of the board is selected by the president of the United States to serve as chairman for a four-year term.

As a further means of ensuring the independence of the Fed, Congress authorized it to buy and sell federal government bonds. This activity is a profitable one that allows the Fed to pay its own bills. The Fed is thus not dependent on a Congress that might otherwise be tempted to force a particular set of policies on it. The Fed is limited in the profits it is allowed to earn; its “excess” profits are returned to the Treasury.

It is important to recognize that the Fed is technically not part of the federal government. Members of the Board of Governors do not legally have to answer to Congress, the president, or anyone else.The president and members of Congress can certainly try to influence the Fed, but they cannot order it to do anything. Congress, however, created the Fed. It could, by passing another law, abolish the Fed’s independence. The Fed can maintain its independence only by keeping the support of Congress—and that sometimes requires being responsive to the wishes of Congress.

In recent years, Congress has sought to increase its oversight of the Fed. The chairman of the Federal Reserve Board is required to report to Congress twice each year on its monetary policy, the set of policies that the central bank can use to influence economic activity.