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How exactly is the Federal Reserve governed?

No one doubts the politics of selecting a Chair of the Federal Reserve. Former Treasury Secretary Lawrence Summers has withdrawn from consideration and Janet Yellen, current Vice Chairwoman of the Board of Governors of the Federal Reserve System, is now the frontrunner. What does the new chair have to expect? In this adapted excerpt from The Federal Reserve: What Everyone Needs to Know, Stephen H. Axilrod answers questions about The Federal Reserve’s role, governance, and evolving responsibilities.

Where does responsibility for monetary policy decisions reside in the Fed?

Though organized as a regional system, with 12 Federal Reserve Banks around the country, monetary policy and other major decisions are made on a national basis. The dominant role is played by the seven-person politically appointed Board of Governors of the Federal Reserve System located in Washington, DC. The Board also oversees operations of the Reserve Banks and approves key decisions such as who will be named presidents of them.

As to monetary policy, Board members are the majority of the 12-member Federal Open Market Committee (FOMC), the central monetary policymaking body within the Fed. It was established by law in early amendments to the Act, attaining its present form in 1942. In addition to seven Board members, the committee includes the president of the Federal Reserve Bank of New York and four of the 11 other regional Reserve Bank presidents serving in annual rotations. The nonvoting presidents also sit at the table at each meeting and participate fully in policy discussions.

Federal Reserve HQ

The Federal Reserve Headquarters in Washington DC, February 2005. Photo by Dan Smith, CC BY 2.5, via via Wikimedia Commons.

How are Reserve Banks governed?

Each regional Reserve Bank is governed by a nine-person Board of Directors, which appoints a president to be CEO, subject to approval by the Board of Governors. By law, the Reserve Bank Board is composed of three so-called Class A directors, who represent the stockholding banks (member banks); three Class B directors, none of whom may be employees of a member bank and who represent the public generally, including various aspects of business, labor, and agriculture; and three Class C directors designated by the Board of Governors also to represent the public broadly, one of whom with “tested” banking experience being chosen as chairman.

With passage of the DFA, Class A directors can no longer cast a vote for president of a Reserve Bank. This represents a shot across the bow to warn the Fed that Congress remains wary of connections between senior Fed officials and top banking executives—a worry aroused by fears that undue interactions might have occurred in the handling of the credit crisis.

Approval by the Board of Governors of the directors’ nominees for Reserve Bank presidencies is usually a fairly smooth process, although some little contention is not unknown. Often Reserve Bank presidents are appointed from within the bank, but it is not unusual for an outsider to be named.

Should Reserve Bank presidents be politically appointed?

Yet another question affecting Reserve Banks, and one more directly related to monetary policy, is raised from time to time and has received some notice in the backwash of the credit crisis. Because Reserve Bank presidents serve on the FOMC, a question is sometimes raised about whether presidents, since they vote on national monetary policy, should be subject to a political appointment process just as the governors of the Fed. Still, the subject has not been actively pressed in the legislature. It raises a host of knotty issues not deemed worth political battles given the obvious practical domination by the politically appointed Board of Governors of the policymaking process during the postwar years.

The present system seems like a good compromise between two extremes. One would be to turn all heads of Reserve Banks into presidential appointees confirmed by the Senate. That approach, however, risks reducing the expertise and objectivity of Reserve Bank presidents if local political debts begin to take precedence in choosing them. The other extreme would be to remove voting rights at the FOMC from all presidents, though not necessarily attendance and full participation in discussions. That approach too has real disadvantages. That all Reserve Bank presidents have an opportunity to vote on monetary policy enhances the prestige of the position, adds a sense of meaning and importance to Reserve Banks in their areas and by extension to the Fed as an institution throughout the country, and probably raises the quality of candidates for the bank presidencies.

A variant would be to make only the president of the New York Fed subject to governmental nomination and confirmation procedures, which did have recent, apparently serious congressional consideration. But that would do little except seem to enhance the standing and influence of Wall Street and major private financial institutions on the nation’s monetary policy relative to other sections of the country.

Stephen H. Axilrod worked from 1952 to 1986 at the Board of Governors of the Federal Reserve System in Washington, D.C., rising to Staff Director for Monetary and Financial Policy and Staff Director and Secretary of the Federal Open Market Committee, the Fed’s main monetary policy arm. Since 1986 he has worked in private markets and as a consultant on monetary policy with foreign monetary authorities. He is the author of The Federal Reserve: What Everyone Needs to Know.

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