The Federal Reserve: power and ownership

Cecil's Columns/Staff Reports
1

Here is the column I am discussing:

On the whole I liked the column, but there are a couple of parts I would have explained differently. For one thing, I don’t think it’s common to refer to the Federal Reserve System as “the Fed”. I think the Fed usually refers to the very top of the system: the Board of Governors and/or the Federal Open Market Committee. (It’s interesting to note that the “Federal Reserve System” link goes straight to the Board of Governors.

No, I’m not saying there really should be a link to the Federal Reserve System itself, since the system is just that - an intangible network of laws, institutions, knowledge, and people. I am making a primarily semantic argument here; if you hate that kind of argument I won’t be sore if you ignore the rest of this post. I am just saying that a stronger distinction should be made between the System and its governing bodies.

Is this a nitpick? I don’t think so. I think failing to make this distinction is a big source of confusion here. In answer to the column’s title “Who Owns the Federal Reserve”, I would answer, “No one, because it’s too large, fragmented, and intangible to be owned.” Private banks are certainly part of the system - the bottom of the pyramid. And they’re private, no different from any other business. So I suppose you could say that the bulk of the System is privately owned (not that I think the “bulk” is the important part).

The top of the system, in contrast, is the Board of Governors - seven Presidential appointees. Their fixed (14-year) terms of service do serve to insulate them from control by the President, but this doesn’t make them private. The Board of Governors is no different from any other independent commission, like the FCC or the Federal Trade Commission.

The Open Market Committee is the seven Governors plus the heads of five of the regional banks … so it, like most of the system, is a hybrid.

My over all point is, we shouldn’t let the public-private hyrbridness of the System as a whole confuse us too much … the most powerful elements of the system are overwhelmingly public-sector. (That is, 100% public sector if you figure the Board of Governors is most important, or 78% public sector if you think the FOMC is most important.)

2

I just thought I would explain my “78% public” statistic. It’s an abstraction. Seven-twelfths of the FOMC are Govenors. Five-twelfths are regional bank heads (President or Chairman, I can’t remember which). Those regional bank heads are elected by the regional boards, which are three-ninths public appointees (they’re chosen by the Board of Governors), and six-ninths representatives of the private organizations which are part of the System. So I made a calculation: 7/12 + 3/9x5/12 = 0.72. Ooops. I guess I did the math wrong the first time.

3

What Cecil said sounds good. It’s there for our own good, and it functions well, maybe in spite of us. And it works. But it only works because Alan Greenspan does the right thing.

But what if the President appointed some guy who was OK at first, but became power hungry, or corrupted, or stupid? He says the Chairman cannot be easily removed. What then?

And why doesn’t other countries have this? Isn’t this a good thing?

And to take this further. If this Greenspan guy is smart and does the right thing. Why don’t we get him to run the country? Someone who is non-partisan, someone who doesn’t want anything. Someone incorruptable, and doesn’t need to run a personality contest in 4 years time.

4

Taking up Major Feelgud’s questions:

Central bank independence is common. Australia (where I’m from) has a not dissimilar system. The Bundesbank (Germany) has historically been even more powerful than the US Fed and the NZ Reserve Bank has since the 1980s been arguably the most independent of them all. Their governmor IIRC is paid according to (the inverse of) the inflation rate. Nobody knows to whom the Bank of England is answerable.

Short answer: you’re screwed. IIRC the Ukranian government appointed someone who was prepared to run the printing presses 25 hours a day if necessary, and it got ugly - the guy just didn’t understand that the numbers could never add up even if he really wanted them to. Other countries have had corrupt or incompetant heads at times. Mind you this is kind of a virtuous circle: governments that function reasonably well as institutions tend to appoint sound governors, but if you happen to be from a country with a disfunctional institutional system it is not clear that you can appoint someone who is and is seen to be clean, nor that this will help much if your government goes on its bungling way. Much of Sth America has been in this unhappy situation. The decision of Equador to give away their currency and dollarise is a recognition that they simply cannot credibly commit to being sensible.

However in most countries, particularly those with a well-developed financial system, there is not much of a temptation to appoint a poor candidate. Appointees tend to be people with a long history of prudence.

Central banking is complicated, but compared to all the rest of government decision-making, it’s a snap. The objective is well-defined: stability of the monetary and banking systems, and whilst there have been from time to time controversies on how to achieve this there is general agreement on the objective.

In matters of broader policy, there is no such agreement. Not only do people disagree on what the answers are, they don’t agree on the questions. In such circumstances it is unlikely that people would agree on a selection method which left voters out of it. But those people who want “a leader” rather than a representative to head the government would agree with you: get someone good and let them get on with it (roughly the position of the recently-defeated Premier of my state BTW).

On the other hand, one can view representative democracy as being in a similar vein to this sort of process - the agent of the people is given flexibility to act within a system of rules. The amount of flexibility we give them depends on the risk of abuse of any such powers, the amount of independence on our fear that we may be tempted to make short term decisions which will turn out to be harmful.

picmr

5

Major Feelgud said,

picmr dealt handily with this one, but I’d like to point out that the Chairman is no dictator. Greenspan owes a lot, probably most, of his power to the fact that he is trusted, respected, and experienced. If he were just some schmo with no sense of monetary policy, he would have little standing among the other six Governors, standing which would be further diluted as you descend through the system. Greenspan is treated as a dictator, or perhaps merely a god, by the press, but we shouldn’t make too much of that. He is the spokesman and the most powerful single member of a small committee which supports him; given that, I wouldn’t expect him to look too much different from a dictator to us mere mortals on the outside of the system.

What would happen if the other six governors were corrupt and/or stupid? Then we would be truly screwed, but this is really not likely. Their terms are staggered - one seat is vacated every two years. So it takes 14 years for the whole membership to turn over (or it would, if nobody retired early). A single president, in office for two terms, would appoint four of the seven members.

6

Jimmy Carter was able to convince Fed Chairman Arthur Burns to step down when he became president. Carter then went through two Fed chairmen (the name of the first one escapes me, but he later became Secretary of the Treasury), but the second was Paul Volcker, who, in addition to tightening the money supply, also stands 6’7".

I’m not quite sure how Carter got Burns to step down, but the Fed chairman has to have some political support to be effective.

7

I heard that you can buy stock in the Fed, and it is basically owned by one of the big investment houses. So that isn’t true?

8

Stock in the Fed? I don’t know, but I’d be very surprised. After all, its goal is not to maximise profit. Commercial banks may be required to hold certain sorts of assets at a central bank, but this would be for prudential purposes, not investment purposes.

9

The question is asked: why is Alan Greenspan not running the country de jure. The reason is that a good banker such as Greenspan is neccesarily conservative in fiscal matters. He is known to be overly cautious at times, in order to maintain his committed policy to stem runaway inflation. The one time he has taken a risk in the past few years, to shore up a huge junk bond that was losing 95% of its value, he was roundly criticized for.
His cautious approach, which works for the economy very well, does not necessarily work well in other arenas of government and foreign policy. Also, as the president he would forced to compromise and negotiate in order to get the terms he wanted, as opposed to his unquestioned dominion he has over the banking system. His cautious approach would definitely not work, for instance, in negotiating with OPEC.