The Federal Reserve’s Role in Full Employment: Part One—History and Structure of the Fed

FederalReserve_System

This is the first part of a four part series on the Federal Reserve and its role in Fixing the Jobs

The Federal Reserve System—responsible for creating and executing the monetary policy of the United States—is the institution with the most power to shape the American economy. Given this reality, the Federal Reserve is the most important player in the push to fix the jobs crisis. At the same time the organization of the Federal Reserve is a mystery to most Americans yet it is important in understanding how policies are created and what interests are most represented. The following is an brief overview of the system and how it is organized.

History and Changes to the Federal Reserve System

The Federal Reserve System was created in response to multiple serious banking crises in the latter half of the 19th century, including what was then known as the Great Depression in the 1870s. The Panic of 1907 was the final crisis that spurred the creation of the Federal Reserve (for a more detail on the creation of the Fed see here). The federal government realized after 71 years of not having a centralized monetary authority that our emerging economy needed a public organization to manage the booms and busts that were frequently occurring (In response to the Panic of 1907, financial titan J.P. Morgan acted as a central bank to bail out struggling banks and facilitate other banks mergers).  In coordination with the major bankers in the United States, US Senator Nelson W. Aldrich and Assistant Secretary of the Treasury A. Piatt Andrew met at Jekyll Island in Georgia to write the legislation that would lead to the creation of the Fed.

The basic structure and composition of the system was a result of compromises between competing interests in order to create a decentralized central bank that was both public and private. The Federal Reserve Act of 1913 created twelve private regional reserve banks that would manage the monetary supply and banks of the assigned region, as well as a board of governors who would oversee these reserve banks.

There have been two major reforms during the century long existence of the Federal Reserve System. The two major reforms were the Banking Acts of 1933 (Glass-Steagall Act) and 1935 and the Federal Reserve Reform Act of 1977. Glass-Steagall put open market operations under Fed authority and gave the Fed more oversight of member banks. In 1935 the Federal Open Market Committee (FOMC) was created and the composition of the Board of Governors was changed to remove the Treasury Secretary and the Comptroller of the Currency. The second major reform, in 1977, “made explicit the Federal Reserve’s objectives, increased its transparency and accountability to Congress, and changed the selection criteria for Federal Reserve Bank directors.” The most important of these reforms was the codification of the Fed’s objectives. Congress created the dual mandate of the Fed to “promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”

Regional Federal Reserve Banks

There are twelve Federal Reserve districts with their own reserve bank that are privately owned by the member banks in each region but act in the public interest and carry out the day to day operations of the Federal Reserve System. The districts have not changed since the creation of the system and some district have multiple branch offices.

Each reserve bank has a nine person board of directors which consists of three different classes (A, B, and C). Class A and B directors are selected by the regional member banks. To represent the interest of different size banks; large banks, medium banks, and small banks elect one director for class A and B directors. Class C directors are selected by the Board of Governors but must hold residence in the district for at least two years. Each class of director has different criteria for selection, 12 U.S. Code § 302 states:

“Class A shall consist of three members, without discrimination on the basis of race, creed, color, sex, or national origin, who shall be chosen by and be representative of the stockholding banks.

Class B shall consist of three members, who shall represent the public and shall be elected without discrimination on the basis of race, creed, color, sex, or national origin, and with due but not exclusive consideration to the interests of agriculture, commerce, industry, services, labor, and consumers.

Class C shall consist of three members who shall be designated by the Board of Governors of the Federal Reserve System. They shall be elected to represent the public, without discrimination on the basis of race, creed, color, sex, or national origin, and with due but not exclusive consideration to the interests of agriculture, commerce, industry, services, labor, and consumers.”

In more simple terms, class B and C directors cannot be officers, directors, or employees of a bank.

These directors select the president and first vice president of their reserve bank.

The Board of Governors

The Board of Governors consists of seven members that are appointed by the president of the United States (approved by the Senate) to serve staggered 14 year terms. There are currently five members with two vacancies. Janet Yellen is the current chair with Stanley Fischer, former governor of the Bank of Israel, as vice chairman. The other three members are:

  • Daniel K. Tarullo: Professor of Law at Georgetown University and former member of the National Economic Council and National Security Council.

  • Jerome H. Powell: former Undersecretary of the Treasury

  • Lael Brainard: former Under Secretary of the Treasury for International Affairs

Federal Open Market Committee (FOMC)

The FOMC is the policy making organization of the Federal Reserve System. It consists of the seven members of the Board of Governors as well as the twelve reserve bank presidents. The members of the Board of Governors are always voting members while only five of the twelve reserve bank presidents have a voting stake at any one time and change on a pre-determined rotation except for the president of Federal Reserve Bank of New York, which has a permanent seat on the FOMC as the vice chair. The chair of the FOMC is also the chair of the Board of Governors. (Here is a list of the current voting members, their alternates, and the future rotation)

In the news when there is a Fed meeting it generally refers to an FOMC meeting where a unified policy is agreed upon. The FOMC is required by law to meet at least four times a year but traditionally the FOMC schedules to meet eight times a year. In recent years, since the Great Recession, the FOMC has held unscheduled meetings as well whenever necessary.

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