The

Decentralized Central Bank:

A Review Essay on The Power and Independence of the Federal Reserve

Narayana R. Kocherlakota
University of Rochester and NBER1
August 29, 2016

Introduction
Peter Conti-Browns new book, The Power and Independence of the Federal Reserve,
is unusual in its focus. Most books about the Federal Reserve System (the Fed)
concentrate on its monetary policy decisions and tend to follow the Feds lead by
highlighting the importance of its independence. Conti-Brown is after much bigger
game: he wants to explain what really makes the Fed tick as an institution. Early on, he
discards the concept of independence as a largely meaningless abstract smoke-screen.
Instead, he zooms in on the legal relationships and governance structures that define
the Fed, and how they have evolved over time.
Based on my time at the Fed (I was President of the Federal Reserve Bank of
Minneapolis from 2009-15), Conti-Browns shift in focus is long overdue. We that is,
Reserve Bank presidents, the governors and our top staff - spent a large fraction of our
time talking and thinking about internal and external governance issues. Much in
statute and Fed rules was unclear. Much that was clear seemed to get in the way of
what we had to get done. Conti-Brown, as a legal scholar, really gets the tangled web
that is the Fed. And, as a writer, he does a masterful job of taking the typical reader into
this web.
The result is that Power and Independence is a wonderfully written book from which
even the most expert Fedhead will learn a lot. I certainly dont agree with all of ContiBrowns conclusions. But he asks an incredible array of novel and engaging questions.
Should the Feds legal counsel be appointed by the President of the United States?
Which non-chair governor in Fed history has been the most powerful? (Hint: it wasnt
world-famous economist Alan Blinder.) Who was Marriner Eccles? And what did John
Maynard Keynes have to say about him when the two finally met?
But this essay is not a review of Power and Independence. It is more of an homage:
inspired by Conti-Brown, I undertake my own investigation and analysis of internal and

1
I thank the editor, Steven Durlauf, for inviting me to write this essay.

external Fed relationships. The resulting conclusions about possible Fed reforms are
distinct from Conti-Browns, and I highlight those differences throughout my essay.
The essay opens with a brief high-level description of the Feds structure. I next turn to
the Feds relationship with its political overseers (Congress and the president). I then
discuss the oversight given by the publicly appointed Board of Governors to the private
sector Reserve Banks. Next, I describe the role of the various Reserve Bank presidents
in the making of monetary policy.
The final section is perhaps the most novel. I describe the large changes in the
composition of Federal Reserve Bank activities and in the Banks internal governance
over the past thirty years. I argue that these changes in activities and governance imply
that the Banks are now quite different than originally envisioned by the Federal Reserve
Act. I suggest that this evolution poses some profound questions about the Feds
future.
Within each of these sections, I reach some conclusions about possible Fed reforms.
As will become clear, my approach to thinking about possible Fed reform is somewhat
different from Conti-Brown. He starts from the base principles that underlie the US legal
system, and then uses those to assess the desirability of Fed reform. This approach
certainly has much to recommend it. However, I will proceed differently. I will largely
take as given the various functions of the Fed, and seek to suggest changes that will
allow it to be more effective in performing these functions.

Fed Basics
In this section, I provide a high-level description of the structure of the Federal Reserve
System (the Fed) and its functions. The material is a little dry, but it contains a lot of
useful context for the discussion that follows.

The Board and the Reserve Banks

The Fed is overseen by a seven-member Board of Governors who are based in
Washington, D. C. The members of the Board of Governors are appointed by the
President and confirmed by the Senate. Their statutory terms are fourteen years.
The Board has a chair and two vice-chairs, one of whom is responsible for the Boards
activities in the supervision and regulation of financial institutions. (The
supervision/regulation vice-chair position was created in 2010 by an Act of Congress,
but the Obama administration has never nominated anyone to fill it.) Each of these three
positions has a four-year statutory term.
The term lengths are somewhat misleading. As Conti-Brown stresses, non-chair

governors dont tend to serve their full terms: the median governor has served around
five years since 1935.2 Chairs have stayed longer since 1935, the median chair has
served around two terms (8 years).
I suspect that one reason why chairs serve longer is that they have a lot more power.
As Conti-Brown emphasizes, this additional power is largely based in Fed rules and
norms, rather than in statute.3 For example, the Board of Governors website points out
that, The Chairman [sic] serves as manager of the Board's staff. That power is an
important one (as Conti-Brown describes), but is not in the Federal Reserve Act. As
well, the chair of the Board of Governors traditionally serves as chair of the monetary
policy-making Federal Open Market Committee. But that power is also not in the
Federal Reserve Act.
Beyond the Board, the System also consists of twelve Reserve Banks that are located
around the country.4 The Banks serve as headquarters for System operations within
twelve distinct geographic districts. Each of the Reserve Banks is, by statute, a
separate private corporate entity with its own Board of Directors, its own president, its
own chief operating officer (called first vice-president by the Fed), and its own
corporate officers.
The composition of the Boards of Directors of the Reserve Banks is established by the
Federal Reserve Act. Each Reserve Bank Board has nine directors, divided into three
classes. The three Class A directors and three class B directors are elected by the
banks in the Reserve Banks geographical district that belong to the Federal Reserve
System. The class A directors are typically commercial bankers themselves, and
required to represent the interests of the banks who belong to the Federal Reserve
System. The class B directors are barred from having a commercial bank affiliation, and
are required to represent the interests of the public. The remaining three class C
directors, who are also barred from having a commercial bank affiliation and also
represent the interests of the public, are appointed by the Board of Governors. The
chair and deputy chair of the Board of Directors are both Class C directors.
The directors are paid essentially nothing beyond expenses for their service, which
typically lasts for two three-year terms.

Federal Reserve Functions

As of 2016, the Fed saw itself as being focused on four activities:5

2
Conti-Brown (2016), p. 181. Hence, I refer to Conti-Brown (2016) in footnotes as PC.
3
PC, p. 70.
4
In Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis,
Minneapolis, Kansas City, Dallas, and San Francisco.
5
See https://www.federalreserve.gov/aboutthefed/mission.htm

1. conducting monetary policy

2. supervising and regulating banking institutions to ensure their safety and
soundness and to protect the rights of consumers
3. maintaining the stability of the financial system
4. providing financial services to depository institutions, the US government, and
foreign official institutions, including playing a major operating role in the
payments system

In this subsection, I discuss how the Fed performs each of these functions.
Monetary Policy

The Fed makes monetary policy primarily through whats called the Federal Open
Market Committee. The Committee has eight permanent members: the members of the
Board of Governors and the President of the Federal Reserve Bank of New York. (By
tradition, but not statute, the New York Fed president serves as vice-chair of the
FOMC.) The other eleven Presidents rotate annually through the four remaining FOMC
positions.6 The FOMC meets eight times per year. All of the Presidents attend and
participate in these meetings, even if they are not voting in that meeting.
As I noted above, the chair of the Board of Governors is, by tradition, the chair of the
FOMC. It is not uncommon for Fed outside observers to treat the chair as if he or she
were the dictator of the FOMC. As Conti-Brown emphasizes, this formulation is unduly
simplistic. Nonetheless, it is true that the chair has considerably more influence over
FOMC decisions than any other meeting participant.
As in many central banks, the staff plays a key role in preparing the FOMC for its

6
Actually, this description of the composition of the FOMC is a combination of statute and
practice. Section 12A of the Federal Reserve Act divides the 12 banks into three fixed groups of
three (Group 1: Boston, Richmond, and Philadelphia; Group 2: Atlanta, St. Louis, and Dallas;
Group 3: Minneapolis, Kansas City, and San Francisco), one group of two (Cleveland and
Chicago) and one group of one (New York). According to statute, on an annual basis, the
directors of the Banks in a given group choose the president or first-vice-President of some
Bank (not necessarily in that group) to be their representative on the FOMC. In these elections,
each Reserve Bank in a group gets one vote. The apparent statutory flexibility has been
hardened into the annual rotation scheme described in the text. I suspect that few, if any,
directors know that the Act gives them the freedom to deviate from the rotation scheme. Its a
great example of how the Fed has used its internal practices to smooth out statutory wrinkles.

deliberations. The structure of staff preparation helps illustrate the nature of the
Committee. Virtually all materials used in the meeting itself are prepared by a
combination of staff who work at the Board of Governors and who work at the Federal
Reserve Bank of New York. Staff at the other eleven Reserve Banks focus most of their
energies on briefing and preparing the President of their specific Bank for the upcoming
meeting. The division of staff work suggests (along with other aspects of the
Committee) that the FOMC participants who are not permanent members of the
Committee are essentially seen as outside members of the Committee.7 Ill return to
this (non-statutory) separation between outside and inside FOMC members later.
There is another aspect to monetary policy that is much less important now than it was
historically. Each Reserve Bank is able to make short-term collateralized loans to banks
in their districts through what is called the discount window. While the lending through
the discount window is usually small, the interest rate on those loans is seen as an
important shaper of overall financial conditions. The Board of Directors of each Reserve
Bank set the discount rate within their Banks district on a biweekly basis. However,
their determination is subject to the review and approval of the Board of Governors in
Washington, D. C. Because of the Boards approval power, the actions of the Boards of
Directors end up being essentially irrelevant: the Board simply sets the discount rate at
the same (Board-determined) level across the country.

Supervision, Regulation, and Financial Stability

The terms supervision and regulation are often used together. But, within the
Federal Reserve System, they generally refer to distinct activities. Regulators follow the
guidance provided by Congress to craft the rules that financial institutions must follow.
Supervisors enforce these rules on particular institutions.
The Board of Governors has supervisory and regulatory authority over a wide range of
financial institutions. However, those authorities are shared differently with the Reserve
Banks. In terms of determining the rules, the Board is in charge, although Reserve
Bank staff may at times provide technical support to Board staff.8 In contrast, the Board

7
I interpreted remarks made by Don Kohn at the Federal Reserve Bank of Bostons
Macroprudential Monetary Policy Conference in October 2015 as being consistent with this
interpretation.
8
Timothy Geithner, who had been President of the Federal Reserve Bank of New York, was
widely criticized for declaring during his Treasury Secretary confirmation hearings that, I just
want to correct one thing. I have never been a regulator, for better or for worse.
(http://www.nytimes.com/2014/05/11/magazine/what-timothy-geithner-reallythinks.html?_r=0) But his statement seems completely consistent with the way that these
terms get used in the Federal Reserve System: Geithner, because he was never a member of

has officially delegated the enforcement of the various rules to the Reserve Banks.
Board staff oversees those delegated activities closely.
This distinction matters somewhat less in terms of financial stability. Again, by statute,
the Board of Governors is in charge of setting regulatory requirements so as to ensure
the stability of the financial system. However, as Conti-Brown describes, there is much
less sense that the enforcement of these regulations has been delegated to the
Reserve Banks.9
Federal Reserve Financial Services
I mentioned above that the Federal Reserve Banks are, legally, separate corporate
entities. But what do these corporate entities do?
At their heart, the Federal Reserve Banks are themselves banks that specialize (now) in
five kinds of financial services. The first three services are different forms of payments
processing: the Reserve Banks process checks, Automated Clearing House (ACH)
electronic payments10, and wire transfers. All of these payments involve a transfer of
funds from one bank account to another, and the sender-receiver banks are the
Reserve Banks customers. The Federal Reserve Banks compete for these bankcustomers with the private sector. However, the Fed is required by statute to charge its
customers enough so as to cover its costs (so that the banks arent receiving a hidden
subsidy of some kind).
The fourth service provided by the Federal Reserve Banks is cash management. The
Federal Reserve Banks accept deposits of paper notes and coins from banks, which are
then credited to the banks reserve accounts with the Fed. The Federal Banks also
issue paper notes and coins to the banks, in exchange for equivalent debits from the
banks reserve accounts. (The Reserve Banks currency issues are required to be fully
collateralized, usually by holdings of US government securities.)
Finally, the Federal Reserve System is also the federal governments bank. Federal
Reserve Banks provide a wide range of services to the Treasury, including maintaining
the Treasurys operating account, and making electronic payments on behalf of the
Treasury. They also provide similar services to other government agencies, like
processing food stamps.

the Board of Governors, did not have any authority to write the rules governing financial
institution only for enforcing those rules. In this sense, he was never a regulator.
9
P. 168, PC. See also:
https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20151124b1.pdf
10
These are typically business-to-business or business-to-person payments that are processed
in batch.

Financial services are fundamentally an information technology business, and (of

course) there has been a lot of innovation in information technology over the past forty
or so years. Later in the essay, Ill discuss how this innovation has led to big changes in
how the Fed provides its payment services and the possible implications for the future
organization of the System.

Political Oversight of the Fed

In this section, Ill discuss how elected officials oversee the Fed. Ill argue that
Congress has little explicit power over the Fed. In particular, as Conti-Brown
emphasizes, Congress has given the Fed a remarkable degree of budgetary freedom.11
In contrast, I see the President as having a great deal of power over the Fed through his
ability to re-appoint the chair. Here, I deviate somewhat from Conti-Brown. He points
out that, over the past eighty years, Presidential oversight has been fluid and shaped a
lot by context and personalities. I agree with his characterization. Nonetheless, the
statutory power of the President seems undeniable and, at least potentially, significantly
weakens the much vaunted independence of the Federal Reserve.
I close the section by arguing that political oversight could be made more effective if
Congress and the President were to establish clearer expectations for the Fed.

Congress and the Fed

On its website, the Federal Reserve Board of Governors says that it is
accountable to Congress.12 Accordingly, the Federal Reserve Board provides (as is
required by statute) a semi-annual monetary policy report to Congress.13 The chair
testifies before committees of both Houses in conjunction with the submission of that
report. As well, as is required by statute, the Federal Reserve Board of Governors
submits an annual report to Congress on the operations of the entire system.
But the Congress really has little power to enforce this supposed accountability. It
cant, for example, fire the chair (or any other member of the Board or FOMC) if the Fed
is seen to be making undesirable choices or achieving undesirable outcomes. Congress
does have the power to set the salaries of the members of the Board of Governors. But
it has not used that power and, in the current day, the salaries of members of the
Board of Governors are already remarkably low compared to the outside opportunities
available to the typical person who holds such a position.

11
PC, p. 199.
12
https://www.federalreserve.gov/faqs/about_12799.htm.
13
Note that this report is submitted by the Board of Governors. The Federal Open Market
Committee does not report to Congress.

It might be thought that Congress could use its control over the budget to influence
the Fed. But, as Conti-Brown describes in one of the most informative parts of his book,
Congress has chosen to give the Federal Reserve System a great deal of budgetary
autonomy. The System is not subject to the usual appropriation process, and is instead
completely self-funding. It generates revenue primarily from its security holdings, net of
any interest that it pays to banks for holding reserves (deposits) in their accounts with
the Fed. This annual net income has been close to $100 billion in recent years. The
Feds annual expenses are around $5 billion per year. So, the Fed does not currently
face anything close to a binding flow budget constraint.
It may seem like this constraint-free situation could change in the coming years.14
As interest rates rise, the Fed faces some risk of its net income falling below zero.
(Basically, the Fed faces a duration mismatch: its liabilities are zero duration bank
reserves and its assets are long duration government securities.) However, in these
circumstances, the Federal Reserves accounting rules are sufficiently flexible to allow
the System to borrow from the Treasury in anticipation of positive net income in future
years.15 So, the Fed can expect to be essentially budget-unconstrained even during
years when its net income falls below zero.
Conti-Brown argues that this budgetary autonomy should be retained, because it
does help insulate monetary policy decision-making from the short-run political
considerations that influence Congress. I largely agree with this oft-made argument.
However, it must be recognized that the Feds budgetary autonomy covers a host of
Fed activities other than monetary policy for which the policy independence argument
may be less compelling.
Congress has been able to drive change at the Fed through its power to amend
the Federal Reserve Act. Conti-Brown explains how, through the history of the Fed,
various Congressmen have used the threat of legislative changes to force the Board of
Governors to adopt partial remedies to their concerns. Thus, in the early 1990s,
Congressman Henry Gonzalez threatened to pass legislation that would require the Fed
to air FOMC meetings in real-time on television. Conti-Brown argues (convincingly) that
this threat induced the Fed to release word-for-word transcripts of FOMC meetings with
a five-year lag.16

14
The Fed transfers any non-spent revenue back to Treasury annually. Interestingly, following
Binder (2013), PC, p. 215, argues that the Fed is not required by statute to make this
remittance.
15
See p. 127, Financial Accounting Manual for Reserve Banks,
https://www.federalreserve.gov/monetarypolicy/files/BSTfinaccountingmanual.pdf.
16
PC, p. 203.

US President Oversight
The president of the United States has considerably more power over the Fed than
Congress does. About a year into each presidential term, the term of the chair of the
Board of Governors ends. The president then has an opportunity to fill that position
(possibly through re-appointment of the existing chair). As noted earlier, the chair is the
most powerful member of the Board of Governors and the most powerful member of the
FOMC. So, the opportunity to appoint a new chair potentially gives the US president a
great deal of influence over the organization.
Conti-Brown argues that, over the course of Fed history, there have often been a
number of forces that served to weaken the presidents ability to use this power.17 This
argument is certainly valid. Nonetheless, the relatively short term of the chair,
combined with the reappointment power vested in the president, does mean that the
chair is confronted with explicitly political incentives in his or her decision-making. Its
conceivable that these incentives could lead the chair to put undue weight on short-term
political considerations in the making of monetary policy.18 Arguably, this kind of
dynamic was at least partly responsible for the Great Inflation in the 1970s.

Clearer Expectations

The chairs semi-annual multi-hour appearances before Congress are often wideranging and unfocused. And it is typically unclear, even to experts, what the president
is seeking when appointing a Fed chair. Both of these issues stem from the same
problem: the existing legislation says little about what is expected from the Fed. The
Fed could be more effective, and elected officials oversight of the Fed could be more
effective, if the organization had a well-specified set of goals for its various activities.
With respect to monetary policy, the Federal Open Market Committee has declared that
it intends to keep Personal Consumption Expenditure (PCE) inflation at 2% over the
longer run. However, neither the Congress nor the president have explicitly signed off
on this objective. As well, the FOMC has not attempted a quantitative formulation of
maximum employment or how to weigh this objective against its inflation goal. It is
exactly this ambiguity that could allow some future president to incentivize the Fed to
make overly easy monetary policy choices.
With respect to bank oversight, there are a number of trade-offs involved. The Fed
could have a better assessment of the risk associated with any particular institution at

17
PC, p. 179.
18
A chair can only be re-appointed with the approval of the Senate. As is well-known, in recent
years, Senate confirmations have become much more challenging. I anticipate that this hurdle
could well become of a source of politically oriented incentives for Fed chairs.

the cost of expending more resources. It could reduce the risk of that institutions failing
at the cost of restricting its lending. How do elected officials want the Fed to weigh these
various competing objectives?
In terms of financial stability, there is both ex-ante policy (designed to reduce the
probability and depth of a crisis) and ex-post policy (designed to reduce the effect of a
crisis if one occurs). With respect to ex-ante policy, the same issues come up as with
ordinary supervision/regulation, and there is the same pressing need for guidance from
elected officials.
With respect to ex-post policy, Congress has been clearer. The Federal Reserve
intervened aggressively to provide liquidity to the financial system in the fall of 2008 and
into 2009. These interventions may have had short-term benefits, but also have the
potential to create moral hazard by subsidizing risk-taking by financial institutions. In
post-crisis legislation, Congress has significantly restricted the ability of the Fed to
provide liquidity in the event of future crises. These safeguards have the benefit of
reducing moral hazard, but have the cost of worsening the impact of any future crisis on
the macro-economy.

Board of Governors Oversight of the Reserve Banks

According to the Federal Reserve Act, the Board of Directors of every Reserve Bank is
responsible for the supervision and control of that Bank.19 Those powers seemingly
create the potential for conflicts of interest. All of the directors are members of the
private sector, and their private sector interests could influence their guidance of the
Bank. Even more specifically, Class A directors are representing the interests of a set of
banks that include ones that are supervised by employees of the Reserve Bank.20 And
those same supervised entities get to vote in the election of class B directors.
In this section, I make two points. First, the apparent conflicts of interest associated
with the Reserve Bank Board of Directors are largely, if not completely, obviated by the
Board of Governors oversight and control over the Reserve Bank. Second, the Board of
Governors exercise of those powers is surprisingly opaque and should be considerably
more transparent to the public.

The Board of Governors Powers Over Reserve Banks

The Board of Governors has enormous powers over the Reserve Banks. In this

19
Specifically, Section 4.6 of the Act.
20
The Federal Reserve System is responsible for supervising any state banks that belong to the
Federal Reserve System. It may also be responsible for supervising holding companies that own
national banks that belong to the System.

10

subsection, Ill discuss in turn the Boards powers over the Reserve Bank presidents,
Reserve Banks supervision of financial institutions, and Reserve Bank budgets.
Reserve Bank Presidents
Much of the public concern about potential conflict of interest is centered on the Board
of Directors influences on the president of the Reserve Bank. In terms of public policy,
Reserve Bank presidents participate in the determination of monetary policy for the
country. In terms of supervision, all Reserve Bank employees report to the president. It
would be inappropriate for either activity to be shaped by the private interests of the
directors.
What kinds of powers do the directors have over the President? The class B and class
C directors (who are not bankers) appoint and re-appoint the President. (The DoddFrank Act of 2010 eliminated the ability of the class A directors to vote on appointment
or re-appointment of bank presidents.) These powers certainly appear to create a
potential conflict of interest.
However, the powers of the Boards of Directors are in fact completely trumped by
powers given to the Board of Governors. No president can be appointed without being
approved by the Board of Governors. No president can be re-appointed without being
approved by the Board of Governors. These final approvals mean that the Board of
Governors can always ensure that the Board of Directors appointment decision is
purely in the public interest, not in the private interest of the Board of Directors. (Note
that, as I described above, the Board of Governors uses its final approval power to
eliminate any say that the Reserve Bank directors have over the discount rate.)
As Conti-Brown emphasizes, a Reserve Banks Board of Directors do have the
collective authority to fire the president of the Bank.21 But the Board of Governors has
the legal authority to fire any Reserve Bank director at any time. This authority could be
used to deter any untoward dismissal of a Reserve Bank president. At the same time,
Conti-Brown argues that the Board of Governors does have the legal authority to fire the
president of a Reserve Bank.22 Again, the powers of the Board of Governors dominate
those of the Reserve Bank Board of Directors.
Compensation is another key way that businesses shape the incentives of their
employees. As I will discuss later, the Board of Governors has final approval authority
over the budgets of the Reserve Banks. It uses that budget authority to establish the
compensation for Reserve Bank presidents, even over the objections of the Boards of
Directors of the Reserve Banks.

21
PC, Page 105.
22
PC, page 256.

11

Conti-Brown recommends that the Reserve Banks should be reformed by vesting the
appointment and dismissal of the Reserve Bank presidents in the Board of
Governors.23 I dont see a need for this reform. The Board of Governors has the final
word on all of these decisions already, and so has the power to shape those decisions
as it sees fit.
Supervision: A Delegated Function
Reserve Bank employees supervise bank and bank holding companies located in their
geographical districts. However, they only do so because the Board of Governors has
delegated that function to the Reserve Bank. Board staff monitor that delegation
closely: my experience in Minneapolis was that no decision of any consequence related
to supervision was reached without approval of relevant staff in Washington. This kind
of close scrutiny from the Board should make it impossible for a director to influence
supervision in an undue fashion.24
Admittedly, this protection from Washington only works if the Board of Governors is
sufficiently rigorous in its approach to possible conflicts of interest. There have been
some unfortunate deficiencies along these lines. In the fall of 2008, Goldman Sachs
became a bank holding company. The change put Stephen Friedman, the chairman of
the New York Feds Board of Directors and a director at Goldman Sachs, in violation of
rules regarding C directors. If the Board of Governors were determined to avoid any
appearance of conflicts of interest, it would have forced Friedmans immediate
resignation. Instead, the Board granted him a waiver to continue in his position.
Friedman ended up being forced to resign in May 2009 because of external criticism, at
considerable reputational loss to both the Federal Reserve System and the Federal

23
PC, page 258.
24
The Federal Reserve Bank of Minneapolis has strict internal rules (available to the public)
regarding the interaction between the Reserve Bank directors and the supervision function:
The Board of Directors is not involved in institution-specific supervision and regulation
matters, nor does it have access to confidential supervisory information. There are some
supervision and regulation matters of an administrative nature which will be considered by the
Board of Directors, such as (i) the approval of the supervision and regulation annual budget; (ii)
review of any Board of Governors operations review reports or internal audit reports of the
function; and (iii) the appointment and compensation of the Banks officers (below the rank of
President) with responsibility for supervision and regulation. Class A and Class B Directors shall
not be involved in the deliberations, nor may they vote on supervision and regulation matters
of an administrative nature. (https://www.mpls.frb.org/about/board-ofdirectors/governance-information/bylaws-of-the-federal-reserve-bank-of-minneapolis) (Recall
class A and class B directors are elected in part by the supervised banks.) The Board of
Governors could choose to impose these kinds of strict internal restrictions on all Reserve
Banks.

12

Reserve Bank of New York.25

Budget
The Board of Governors has the final approval authority over Reserve Bank annual
budgets (as described in this document
http://www.federalreserve.gov/foia/files/2016ReserveBankBudgets.pdf). This final
approval authority gives the Board the ability to establish priorities and compensation for
the Reserve Banks, even if their choices are in conflict with the desires of the Banks
Boards of Directors. For example, in the early 2010s, the Board of Governors imposed
a multi-year base salary freeze on all officers of Reserve Banks (so as to mimic a
similar restriction that had been imposed on high-ranking federal government
employees).

Opaqueness of Public Oversight

The main message of the prior subsection is that the publicly appointed Board of
Governors has a wide range of powers that provide it with oversight and control over the
Reserve Banks. These powers are sufficient to obviate any potential conflicts of interest
represented by the Banks Boards of Directors. But there is a problem: it is currently
hard for the public to see whether the Board of Governors is using these powers
appropriately. In this subsection, I argue that the Board of Governors, as agents of the
public, can and should be considerably more transparent about its oversight over the
Federal Reserve Banks.
Appointment/Re-Appointment of Reserve Bank Presidents
The Board of Governors has to vote to approve every Reserve Bank presidential
appointment. These votes to fill key policy positions are among the more important
actions that are taken by the Board. But the Board holds these important votes in
private (as opposed, for example, to many public Board votes on regulations). There is
(rightly) tremendous public interest in the considerations that go into the appointment of
Reserve Bank presidents. The Board can meet this interest by making its deliberations
over each appointment open to the public. The public can then see how the Board is
dealing with challenging and important issues like the limited diversity of Reserve Bank
presidents.26
As mentioned earlier, Reserve Bank presidents have five-year terms. There is nothing
in the Federal Reserve Act that suggests that Reserve Bank presidents should be

25
It is also interesting to ask: why did the Federal Reserve Board of Governors ever appoint a
Goldman Sachs director to represent the public interest on the New York Feds Board?
26
There have been no African-American or Latino Reserve Bank presidents in the one hundredplus years of the Feds existence.

13

automatically reappointed to new terms.27 However, the Board has established a nonstatutory rule under which the five-year terms of all Reserve Bank presidents end on the
same day. This rule makes it challenging, if not impossible, for the Board of Governors
to undertake rigorous case-by-case performance evaluations. The Board should instead
adopt a process that allows its re-appointment decision to be based on a detailed
performance evaluation. And, as with the appointment decision itself, the Board should
see itself as the agent of the public and be highly transparent about the nature of its
evaluation.

More General Forms of Oversight

The publicly appointed Board of Governors is engaged in many forms of oversight over
the private Reserve Banks. The Board conducts this oversight on behalf of the public. It
makes sense, then, that the results of the Boards oversight efforts should be much
more broadly shared with the public.
This enhanced transparency is probably most important with respect to supervision.
Many observers including some members of Congress seem uninformed about the
(entirely appropriate) large extent to which the Board of Governors and its staff are
involved in bank supervision. As a result, there is a perception that Reserve Bank
presidents and their Boards of Directors conduct a Fed supervisory program that is
riddled with conflicts of interest. By being a lot more transparent with the public about its
oversight of Reserve Bank supervision, the Board of Governors can and should be
demonstrating the falseness of this perception.
Congress was at least implicitly asking for exactly this kind of transparency when it
created the position of a vice-chair of the Board of Governors for supervision and
regulation. I agree with Conti-Brown that it is vexing (to use his word)28 that President
Obama has not nominated anyone for that position over the past six years.

Monetary Policy Role of the Reserve Banks

As described earlier, the Reserve Banks play two roles in the determination of monetary
policy: the presidents participate and vote in Federal Open Market Committee (FOMC)
meetings and the Boards of Directors determine their Reserve Banks discount rate
(subject to the approval of the Board of Governors).

27
A side comment: The current chair and vice-chair of the Board of Governors are both highly
effective but are also both over 65 years old. So, it seems odd that the Board has a nonstatutory rule that requires Reserve Bank presidents with more than ten years of service to
retire when they reach 65 years of age.
28
PC, p. 247.

14

The Role of the Non-New York Bank Presidents in FOMC Meetings

In this subsection, I discuss the three roles that the non-New York Reserve Bank
Presidents play at the FOMC.
The first role has to do with combatting groupthink. The permanent members of the
FOMC rely primarily on a briefing prepared by staff based in New York and Washington.
The result is that they tend to see the policy issues in similar ways. Thus, in the past
twenty years, there have only been two occasions when a permanent member of the
FOMC voted against a decision of the Committees.
In this cosy environment, the eleven non-New York presidents are a much-needed
disruptive force. They prepare for the FOMC meetings independently from the Board.
They are briefed and advised by staff who are largely segregated from the core FOMC
staff process. As a result, they are more likely to present views that clash possibly
greatly - with the collective perspective of the permanent members. For example, in
October 2010, Thomas Hoenig, president of the Federal Reserve Bank of Kansas City
(and a voter) referred to the FOMCs much-anticipated quantitative easing decision as
a bargain with the devil in a speech.29
Conti-Brown recommends that the presidents be stripped of their FOMC votes. I think
that the FOMC would lose a lot if there were no rotating voters. Unlike the permanent
voters, the eleven non-New York presidents have dissented on many occasions over
the past twenty years. Appropriately, these dissents by voters who are essentially
outside members of the FOMC do not sway that the Committee from its chosen path.30
But the dissents serve as a powerful signal to the public that the Committee has only
made its decision after considering a range of alternative perspectives in its
deliberations.
The non-New York presidents, including the non-voting ones, also play a key role in
facilitating two-way communication between the Federal Reserve and the public. On
the one hand, the presidents regularly discuss local economic intelligence in the FOMC
meetings. On the other hand, the presidents travel widely in their geographic districts,
discussing the FOMCs decisions with a broad cross-section of Americans.
Earlier, I argued that the Board of Governors should be much more public in how it
conducts its oversight of the Reserve Bank presidents. The above discussion suggests
yet another reason why this transparency is needed. The Board has enormous power
over the eleven FOMC participants who are non-permanent members of the Committee.

29
http://money.cnn.com/2010/10/29/news/economy/quantitative_easing_liquidity_trap/
30
On multiple occasions over the past five years, the FOMC has gone forward with its decisions
over the objections of as many as three rotating voters.

15

But it has to use that power judiciously or risk destroying the participants incentives to
bring forward valuable external perspectives. The public should be able to see whether
the Board is, in fact, using its power appropriately along these lines.

What About New York?

In the previous subsection, I defended the voting role of the eleven non-New York
presidents in the FOMC. Perhaps counterintuitively, I think that it is much harder to
defend the New York Fed presidents voting role.
The issue is twofold. First, the New York Fed president is, at a minimum, a clear insider
in Committee deliberations. He/she is, by tradition, the vice-chair of the FOMC. Along
with staff in Washington, New York Fed staff play a major role in briefing the permanent
members of the Committee. So, the New York Fed president is not playing the same
role of a needed disruptor in the making of monetary policy.
Second, the primary two-way communication that the New York Fed president and New
York Fed staff facilitate is between Wall Street and the FOMC. To be clear, this kind of
communication is incredibly necessary for monetary policy to be effective, the Fed has
to know what traders think and traders have to know what the Fed thinks. But, in the
presence of the New York Feds insider role in monetary policy-making, this relationship
has the poisonous side-effect of creating the appearance that Wall Street firms are
shaping Fed decision-making.31
Confronted with these issues, some observers have suggested that the president of the
New York Fed should be made an appointment of the US president, subject to
confirmation by the Senate. I think that there are a number of problems with this
change. The most important is that I agree with Conti-Brown that this change would
likely increase the power of the New York Fed within the Committee and thereby
increase the relevant conflicts of interest.32
These considerations lead me to a much simpler solution: strip the New York Fed
president of his or her FOMC vote. It would still be of value for the New York Fed
president to participate and contribute in the meetings. But removing New Yorks vote
would greatly rationalize the Committees structure. Monetary policy would primarily be
made by the Board of Governors (appointed by the President of the United States).
However, the Boards decision-making would be subject to the ongoing review provided
by the rotating outside members (living in the provinces, appointed/re-appointed by the

31
As suggested in this pointedly satirical video:
https://www.youtube.com/watch?v=PTUY16CkS-k.
32
PC, p. 258.

16

Board, and briefed by separate staff).33

Discount Window?
As I described earlier, Reserve Bank directors establish, on a biweekly basis, the
interest rate at which banks can borrow from the Reserve Banks discount window. In
my view, this process badly needs to be reformed.
First, the directors are not employed by the Federal Reserve System. They are
members of the private sector, with private sector interests. Why should they be setting
monetary policy?
Second, in reaching their decision, the directors rely on briefings from Reserve Bank
employees. These briefings can reveal the thinking of the Reserve Bank president (who
may well be an FOMC voter) about monetary policy to the directors, who are members
of the private sector. Along those lines, it is often argued that the Reserve Bank
directors decision about the discount rate are useful predictors of how the presidents
will end up voting at the FOMC.
For both of these reasons, it would be better for the directors to be removed from the
process of determining the discount rate. In my view, there would be essentially no loss
in doing so. The Board of Governors has the power to approve the directors decisions.
The Board routinely uses that power to set the discount rate to whatever value it deems
appropriate.34

Financial Services and the Future of the Reserve Banks

I now turn to the evolution of financial services over the past twenty years and its impact
on the Reserve Banks. My main theme is that the technological change that has
occurred has had big effects on the Federal Reserve Banks.

33
This proposal may not require any statutory change. As discussed in footnote 6, the Federal
Reserve Act says that the New York Board of Directors elects, on an annual basis, a
representative on the FOMC from the set of presidents and first vice-presidents. There does not
seem to be any statutory reason why the New York Board cant simply, on an ongoing basis,
cast its vote for one of the four incoming presidential members of the FOMC.
34
It is unclear to me whether this reform requires a statutory change. Section 14 of the Federal
Reserve Act refers to Reserve Banks setting the discount rate every two weeks. However, the
Act does not seem to require that this decision has to be made by the directors of the Bank. I
dont see any statutory reason why the directors couldnt simply permanently delegate the
discount rate decision to the president of the Bank.

17

Federal Reserve Financial Services: Changes in Employment

To understand the relevant changes, its useful to begin with the very first annual budget
review that the Federal Reserve Board of Governors issued for the fiscal year 198586.35 In 1985, the twelve Reserve Banks had around 13000 employees, outside of
support and overhead.36 Of these 13000, about 10500 employees were in financial
services in the business of processing cash, Treasury, check, ACH or wire transfers.
In other words, outside of support and overhead, nearly 80% of Reserve Bank staff
were employed in 1985 in the provision of Federal Reserve Financial Services to banks
and the government.
If we move forward in time to 2002, these numbers had changed only slightly. The
Reserve Banks had just under 13000 employees, outside of support and overhead.
Nearly of them were in financial services. As in 1985, over 5000 were engaged in the
Feds payments business (processing checks, ACH payments, and wire transfers)
aimed at financial institutions.37
Fast forward to 2012, and the situation has changed greatly.38 The twelve Reserve
Banks had just under 10000 employees outside of support and overhead.39 Of these,
fewer than half were in financial services. Fewer than a thousand of those were
employed in the Banks payments business (check, ACH, or wire). Thats a decline in a
ten-year span of over 80% in the number of employees who work in payments.
What happened? The composition of Reserve Bank employment has evolved because
of technological change in the payments business. This is probably most obvious with
respect to checks. In 1985, checks were objects that had to be moved physically
around the country. By 2013, checks have become just another type of computer
image that can be virtually transferred and processed.
If the Reserve Banks are no longer in the payments business, what are they doing?
The number of employees involved in the processing of cash and federal government
payments also fell from 2002-2012 (but by less than 15%). However, as of 2012, the
number of employees engaged in monetary policy had risen by about 50% since 1985
(and by nearly 50% since 2002). The number of employees engaged in supervision and

35
Table 5.5 of 1985-86 Annual Budget Review of the Federal Reserve System:
https://fraser.stlouisfed.org/docs/publications/bog_arbr/ar_budgetrev_1985-86.pdf
36
The number of employees engaged in support and overhead activities has also fallen
markedly, but that pattern is tangential to my focus in this section.
37
Table E4 of 2003 Annual Budget Review of the Federal Reserve System:
http://www.federalreserve.gov/boarddocs/rptcongress/br03.pdf.
38
As far as I can tell, the System stopped including head counts in its budget reviews as of 2013.
39
Federal Reserve Annual Budget Review, 2013, Table C4:
http://www.federalreserve.gov/publications/budget-review/2013-appendix-c-expenses-andemployment-at-the-federal-reserve-banks.htm.

18

regulation had risen by about 100% since 1985 (and by about 1/3 since 2002). The
Reserve Banks are much less banks for banks, and much more public policy
institutions, than they were in 1985 or 2002.
Will this change in employment continue? As I noted, the number of employees in the
three payments services had fallen below a thousand by 2012. It cant fall much further.
So, theres a limit to how much more change of that kind can take place. But I do
anticipate further declines in the number of employees involved in cash and federal
government payments. At the same time, it seems likely to me that we could see further
increases in the number of employees engaged in supervision and regulation or
monetary policy.

Federal Reserve Financial Services: Changes in Organization

Over the past thirty years, the Fed has made big changes in its internal governance
over financial services.
If we go back to 1985, each Federal Reserve Bank was independently responsible for
providing the five financial services (check, ACH, wire, cash, and Treasury) to its
District. The 1985 annual report of the Federal Reserve Bank of Chicago discusses this
aspect of its activities in some detail on pp. 17-19.40
That is no longer the case. The management of these services has become centralized
across different Federal Reserve districts. For example, the executive leadership of the
retail services (check and ACH) is based in Atlanta.41 The executive leadership of the
wholesale services (wire) is based in New York.42 The executive leadership of cash
management is based in San Francisco.43
The trend to cross-district centralization of the management of business lines has also
occurred in support areas. The most notable of these is probably information
technology: the fraction of Federal Reserve Bank employees who work for the
centralized Federal Reserve Information Technology office (located in Richmond) has
more than doubled during the current millennium.44 That office now has more than 5%
of all Reserve Bank staff.
This kind of centralization of management has a lot of benefits. It ensures that different
Reserve Banks arent following distinct strategies with respect to the provision of

40
https://fraser.stlouisfed.org/docs/historical/frbchi/frbchi_annual_1985.pdf.
41
For details, see this website: https://www.frbatlanta.org/about/atlantafed/officers/rpo.aspx.
42
For details, see this website: https://www.newyorkfed.org/aboutthefed/org_wholesale.html.
43
For details, see this website: http://www.frbsf.org/cash/federal-reserve-role-cashdistribution/cash-product-office.
44
For details, see this website: http://www.federalreserve.gov/publications/annualreport/2015-federal-reserve-system-budgets.htm#xfederalreservebanksbudgets-f2c5aba5

19

payment services or information technology. And there are clear efficiency gains
associated with having one leadership team for the Federal Reserves activities in, say,
ACH, as opposed to twelve.
However, this centralization does have a key cost. As I noted earlier, the Federal
Reserve System consists of twelve distinct corporate entities. This structure is welldesigned to make decisions about how to allocate resources between different functions
(like monetary policy support and cash management) within a Reserve Bank. It is not
well-designed to make trade-offs across activities situated in different Reserve Banks
(like ACH in Atlanta and monetary policy in Minneapolis). Effective decision-making
about those trade-offs would require some kind of centralized management team, with
authority to allocate resources across different districts and functional areas.

Two Questions About the Future

The Federal Reserve System was set up in 1913 to consist of twelve Reserve Banks
(operating under the oversight of a Federal Reserve Board). The Reserve Banks were
separate corporate entities designed to provide services to commercial banks.
The problem is that this 20th century formulation seems increasingly out of step with the
21st century activities in the Reserve Banks. The Reserve Banks are mainly about
monetary policy and bank supervision that is, public policy. They dont need to be
and probably shouldnt be private sector entities to accomplish these public policy
missions effectively. And the Banks are increasingly managing their businesses
collectively. Being separate corporate entities isnt helpful in that regard.
Both of these considerations suggest that Congress needs to ask the following
question:

Should the Federal Reserve System of the Board of Governors and twelve
distinct Reserve Banks be collapsed into a single public entity?

If the answer to this question is affirmative, then Congress faces a second question.

If the Fed becomes a unified public entity, how should Congress maintain the
basic (and I would argue beneficial) structure of the Federal Open Market
Committee, with a small number of outside members who are well-prepared to
play a needed disruptive role within the Committee and to provide two-way
communication with the public?

At the risk of repeating: Im not raising these questions because of particular monetary
policy or supervisory policy failures. Rather, the Fed has changed a lot in the past
fifteen to thirty years. It seems appropriate to re-examine its basic structure in light of
those changes.

20

Conclusions
In this essay, Ive discussed several aspects of the Federal Reserve:
Political oversight
Board oversight of the Reserve Banks
Reserve Bank presidents participation in the making of monetary policy
Change in the activities and internal governance of the System
in some detail. My analysis has led me to suggest four reforms:
1. Congress should more clearly define its expectations for the outcomes of Fed
monetary policy, supervision, and financial stability policy.
2. The Board of Governors should enhance the transparency of its oversight over
the Reserve Banks, and in particular its decisions about the
appointment/reappointment of Reserve Bank presidents.
3. The president of the New York Fed should lose his/her vote on monetary policy.
The Reserve Bank directors should be removed from the process that
determines the discount rate.
4. There should be a public conversation about two questions: Given the changes
in Reserve Bank functions, should the Fed become a unified public entity? If so,
how should Congress maintain the structure of the FOMC?

The second and third reforms may require only internal changes to Federal Reserve
rules.
It is useful to compare my suggested reforms with Conti-Browns. He recommends that
two key Board staff positions be made POTUS appointments and that the presidents of
the Reserve Banks all lose their votes. We arrive at different places because we start at
different places: He is more interested in ensuring that the governance of the System
aligns with the core legal principles of the US. This is a worthy objective but it
nonetheless feels somewhat abstract to me. My aim is instead to find ways for the
System to fulfill its objectives in a more effective fashion.
My hope, though, is that his views and my views are merely the beginning of a
conversation, not the end. The Feds decision-making in many public policy arenas is
shaped in subtle and important ways by its structure. It would be valuable to have a lot
more scholarship exploring that structure, how it came to be, and how it should be
changed.

21

References

Binder, Sarah. Would Congress Care if the Federal Reserve Lost Money? A Lesson From
History, Monkey Cage, 2013.

Conti-Brown, Peter. The Power and Independence of the Federal Reserve. Princeton: Princeton
University Press, 2016.

22