Federal Reserve Independence

Transcription

1 a c h a n g i n g s tr u c tu r e O n f o r c h a n g i n g tim e s Federal Reserve Independence F e d e r a l R e s e r v e B a n k o f M in n e a p o lis A n n u a l R e p o rt

2 Perspectives on Federal Reserve Independence a changing structure for changing times Federal Reserve Bank of Minneapolis Annual Report 1976 To provide for the establishm ent of Federal reserve banks, to furnish an elastic currency, to afford m e a n s of rediscounting commercial paper, to establish a m ore effective supervision of banking in the United States, an d for other purposes.

3 Perspectives on Independence. How Structure Affects the Function of Monetary Policy Our 200th year, perhaps m ore than m ost years, h as g enerated its sh are of questions about m onetary policy an d about the role of the Federal Reserve S ystem the nation s central b an k in solving our econom ic problem s. Over the past few years, the dual problem s of inflation and un em ploym ent have b een especially vexing. And questions about how effectively our m oney m anagers are responding to such problem s reflect the urgency an d complexity of the inflation/ unem ploym ent dilem m a. T hese questions also reflect increasing reliance on m onetary policy m anaging the supply of m oney an d credit as a m ean s of assuring national econom ic health. That em p h asis has grown as w e have had to cope with large deficits and difficult econom ic events such as the energy crisis, fluctuating foreign currencies, and continuing post-vietnam adjustm ents. The focus on m onetary policy h as g enerated questions not only about policy actions, but about the structure an d pow er relationships of the Federal Reserve System questions about its independence. Differences of opinion over m onetary policy actions are to be expected, regardless of how the System is structured. Given the limits of h u m an w isdom an d the incom plete state of our econom ic knowledge, such differences are normal an d inherent. That there is such disagreem ent d oes not m ean the procedures are wrong or the structure inappropriate. If, on the other hand, the structural m ake-up of the System, or its procedures, tends to inhibit developm ent an d im plem entation of good policy decisions, then w e can try to im prove those structures an d procedures. Since our world is changing an d issues seem to be getting more com plex, it would be surprising if som e adjustm ents in the m ech a nism s for m onetary m an ag em en t might not prove useful. It s against

4 this background that the various proposals to ch an g e the structure an d limit the in d e p en d en ce of the Federal Reserve System deserv e to be discussed. T h e S e m a n tic s o f F e d In d e p e n d e n c e Quite probably the term in d ep e n d e n ce has b een over used. It w as a key concept in the design of our central banking sy stem but in a relative sen se, not as an absolute. What d o es in d ep e n d e n ce m ean? Is the Federal Reserve accountable? Is it responsive to changing national priorities? First, let s be clear on w hat in d ep en d en ce d oes not m ean. It d oes not m ean decisions an d actions m a d e without accountability. By law and by established procedures, the System is clearly accountable to C ongress not only for its m onetary policy actions, but also for its regulatory responsibilities an d for services to banks an d to the public. Nor d oes in d ep en d en ce m ean that m onetary policy actions should be free from public discussion an d criticism by m em bers of Congress, by professional econom ists in an d out of governm ent, by financial, business, and com m unity leaders, an d by informed citizens. Nor d oes it m ean that the Fed is in d ep en d en t of the governm ent. Although closely interfaced with com m ercial banking, the Fed is clearly a public institution, functioning within a discipline of responsibility to the public interest. It h as a degree of in d ep en d en ce within the governm ent w hich is quite different from being independent of governm ent. Thus, the Federal Reserve System is m ore appropriately thought of as being insulated from, rather than in d ependen t of, politicalgovernm ent and banking-special interest pressures. Through their 14-year term s and staggered appointm ents, for exam ple, m em bers of the Board of Governors are insulated from being d ep en d en t on or beholden to the current adm inistration or party in power. In this and in other w ays, then, the m onetary process is insulated but not isolated from th ese influences. In a functional sen se, the insulated structure enables m onetary policy m akers to look beyond short term pressures an d political expedients w h enever the long-term goals of sustainable growth and stable prices m ay require unpopular policy actions. Monetary ju d g m en ts m ust be able to w eigh as objectively as possible the merit of short-term expedients against long-term c o n se q u e n c e s in the ongoing public interest. M o n etary P o w e r... Monetary decisions have special im portance b ecau se of their im pact on all other asp ects of our econom ic life. In a very real way, the pow er to create m oney also carries the pow er to destroy its value. Pushed to

5 Much a s they m ay contribute to the country s progress, m onetary p o w e rs... are not omnipotent. To be effective... they m u st be closely coordinated with the other m ajor pow ers an d policies of governm ent which influence the country s econom ic life. President Franklin D. Roosevelt, 1937 extrem es of m isjudgm ent or illadvised action, m isuse of m onetary pow er can erode values an d destroy the econom ic fabric of the society it serv es by inflation, boom bust depression, im m oderate stimulus, or by excessive restraint....and Its L im its While m onetary policym akers have great potential pow er over the econom y, there is m isunderstanding about the practical limits of such power. Typically, m onetary policy can restrain credit expansion m ore effectively than it can stim ulate borrowing, it can control the supply of m oney, but not the d em an d for it. It can influence interest rates, but not control them. The central bank can influence only a few of several factors that determ ine the course and vigor of econom ic perform ance. The problem s are com plex an d constantly changing, our know ledge is never com plete, and m echanism s for avoiding harmful policy side-effects are not adequately developed. Finally, the ultimate effects of m onetary actions are not precisely know n until m onths later, if at all. Thus, just as responsible m onetary policy m ust avoid extrem e actions w hich on b alance m ay be m ore harmful then helpful to the econom y so m ust the public be restrained in its expectations as to w hat m onetary policy alone, how ever well m anaged, can accomplish. T h e L a w m a k e r s R ole Politicians, the elected representatives w ho m ake our law s and determ ine public policy, are them selves subject to pressures inherent in our structure of governm ent. They are expected to respond to the desires an d n e ed s of their constituents. And constituent expectations tend not to be tem pered by such realities as cost an d resource limits. In short, politicians are under pressure to acco m plish m ore than available resources permit. That can m ean attem pting m ore than w e can afford or are willing to pay for. Put another way: 3

6 it is easier to vote for n eed ed program s than for increased taxes. Such pressures probably give our national policies an d goals an inflationary tilt. This is especially true in a dem ocracy w here the powers delegated to our elected officials m ust be affirmed by back hom e constituents every two, four or six years. The n eed for our elected representatives to b e responsive and tuned in to their constituents is a vital function in our political process. It provides important g u aran tees to citizens. But it m ay also limit the extent to which elected representatives can afford to consider the long-term merits of policies. Policy actions that m ay lead to defeat in the next election, how ever valid, are not likely to be seen as attractive options. Balanced policy therefore requires an institutional structure that insulates m onetary policym akers from such short-term pressures which is to say, one that also insulates elected officials from the negative electoral co n seq u en ces of policy decisions that m ay be essential but unpopular. Obviously, not all policy decisions pose this type of conflict. Not all elected officials yield to short-run pressures or would need to. In any case, the merits of a given policy are seldom unam biguous. But the co n se q u e n c e s of persistently expansive m onetary policy are too severe to risk procedures that com pound a bias in favor of short-run options an d produce short sighted results. O th er M oney Historically, w e have used a variety of m echanism s to m anage m o n ey a stock of silver and gold bullion or currency backed by metals. T hese m echanism s regulated the m oney supply according to irrelevant ch an g es in our stock of m etals and offered little or no consideration of actual n ee d s of the econom y, short- or long-term. Our ow n history, and the experiences of other nations, are replete with exam ples of ru n a w a y inflation and econom ic chaos that developed b ecau se the lure of superficial solutions outw eighed responsible but less popular policy actions. Out of long experience, our m onetary system h as evolved so that the supply of m oney and credit are m a n a g e d at levels intended to be m ost conducive to stability, growth, an d a high level of production an d em ploym ent in our national econom y. That responsibility requires not only a high d egree of technical know ledge about the econom y an d the interaction of its different elem ents and forces but also requires objective, in d ep en d en t judgm ents about the best m onetary adjustm ents to help achieve those national goals. H istory o f R efo rm s Over the years the Federal Reserve System has proved rem arkably ad ap tab le to changing needs. Both policies an d procedures have b een altered w h en the need for ch an g e becam e clear som etim es 4

7 by statutes or am en d m en t to the Federal Reserve Act, often by policy an d adm inistrative im plem entation within the authority of the Act. The Federal Reserve System w as barely in operation w hen it b ecam e apparen t that purch ases of governm ent securities, now the m ain m echanism for influencing the m oney supply, ad d e d to bank reserves an d thus b ecam e an unexpected m echanism for effecting m onetary expansion. The Banking Acts of 1933 and 1935 reaffirmed and strengthened the Federal R eserve s in d e p en d e n ce from the executive b ran ch they rem oved the Comptroller of the Currency and the Secretary of the Treasury from the Federal Reserve Board and affirmed its indep en d en t budget an d incom e procedures. They delegated to the Fed the pow er to control stock margin requirem ents and to regulate savings interest rates. World War 11 saw the central bank directly supporting the financing of u n p reced en ted w ar expenditures with su b seq u en t m onetization of that debt after the war. in the fam ous accord of , after lengthy d e b ate both public and within governm ent, it w as agreed that the Federal Reserve w ould no longer support (by its p urchases of governm ent securities) the artificially low interest rates and par values for financing governm ent debt. Thus e n d ed the dom ination of m onetary policy by the Treasury s n eed s to finance its m assive war-born debt. The Em ploym ent Act of affirmed m axim um em ploym ent as one of the goals of Federal Reserve policy, establishing formally that m onetary policy has a responsibility to support and help im plem ent national objectives. In m ore recent developm ents, Congress h as delegated additional authority to the Fed under the C onsum er Protection Act to regulate Truth in Lending, Equal Credit Opportunity an d other consum er interests. Over the years, it b ecam e clear that m onetary policy had to be uniform throughout the nation, that regional variations w ere not possible. Yet the concept of a federal system, with input from various regional perspectives, w as important in the policy process. The establishm ent of the so-called Federal Open Market Com m ittee (FOMC), com bining the Board of Governors and five Federal Reserve Bank presidents as the major policy-making body, represented a major structural innovation that accom m odated the n e e d ed change. I n d e p e n d e n t... F ro m W hom R epresentative Carter Glass an d his congressional contem poraries w orked out the rem arkably durable provisions of the Federal Reserve Act within the context of our federal system of structural checks an d balances. The term s of the sev en Federal Reserve Board m em b ers ( 14 years*) are not so long or u n ch an g eab le as the life-time 'O r ig in a lly B o a r d t e r m s w e r e 1 0 y e a r s, c h a n g e d to 12 y e a r s in a n d to 1 4 y e a r s in

8 Federal R eserve C hairm an A rthur B urns testified before congressional com m ittees 13 tim es in Other m em b ers of the Board a lso m ake frequent a p p e a ra n c e s before Congress. appointm ents of justices to the S uprem e Court, but are long enough to m ake the partisan political prospects of a next election substantially irrelevant. Ultimately the System is accountable to Congress, not the executive branch, ev en though Reserve Board m em b ers an d the chairm an are president-appointed. The authority and delegated policy pow ers are subject to review by the C ongress not the president, the Treasury D epartm ent, nor by banks or other interests. B ecause the Federal Reserve System finances its operations from internally gen erated incom e, it d o es not d e p e n d on congressional budget appropriations. This is an essential elem ent of insulation, since the pow er to appropriate budgets is the pow er to control. This principle w as reaffirmed in the Banking Act of an d again in the G overnm ent Corporation Control Act of Digitized for FRASER 6

9 The ch eck an d b alance structure extends in other w ays. Directors of regional banks are required to represent borrowers an d the general public as well as ban k s and lenders. The regional structure itself en su res the representation of varied regional interests in econom ic research and policy formulation, as well as directly on the FOMC. M embers of the Board of Governors m ust them selves be geographically representative. Finally, an im portant elem ent of insulation results from the ability to have policy deliberations conducted in a m an n er an d clim ate that en su res m axim um candor by all staff and officials involved. Alternative policies cannot be discussed fully and realistically without such candor. P re s s u re s fo r R eform Pressures for reform of the Federal Reserve System stem from three kinds of concerns: (a) disagreem ent with m onetary policy, (b) disag reem en t with how the System functions in a procedural context, an d (c) disagreem ent as to its accountability to Congress, to the executive branch, to the public. D isagreem ents over m onetary policy are inherent. Knowledgeable m onetary experts an d econom ic professionals can an d often do disagree over appropriate action, timing, m ethods of im plem entation and d eg ree of em phasis. Typically, there is m ore disagreem ent over the precise degree of restraint or stim ulus than over the direction of policy, w hether restraint or stimulus. But disagreem ent over policy is normally healthy disagreem ent. It does not in itself justify reform unless policies are clearly bad, and clearly bad for reasons of structural dysfunction. Critics of m onetary policy often cite the n eed to coordinate m o n e tary with other national econom ic policies: the various agencies of governm ent should not work at cross-purposes. Working at cross purposes can be wasteful an d inefficient. It m ay be an indication of bad policy on the part of one ag en cy or on the part of all. But agreed upon policy objectives often conflict in im plem entation as w hen w e seek m ore good things than limited resources can provide, or w hen lower interest rates also m ean m ore inflation. The populist goals of readily available credit at low interest on the one hand, and the dan g ers of rising prices, inflation an d su b seq u en t recession on the other, are the classic issues of m onetary/econom ic policy debate, about w hich there is not only honest argum ent but also inherent conflict. At times, rapid increases in federal expenditures an d deficits have forced over-reliance on m onetary restraint to curtail inflation. In the context of ch eck s an d balances, it can be prudent to have a system w here not all agencies or branches of governm ent are required to arrive at the sa m e judgm ent concerning the nation s econom ic n e e d s an d prospects. Digitized for FRASER 7

10 Other criticisms stem from the fact that the Federal Reserve System, as our central bank, is institutionally related to banking e sp e cially m em b er banks. M ember banks elect six of the nine directors of each regional Federal Reserve Bank. And each m em b er bank ow ns nom inal stock in its district Federal Reserve Bank. Boards of regional Federal Reserve Banks have been, de facto, largely representative of banking, financial and business interests m ore or less by deliberate policy. U nderstandably, the boards of regional Reserve Banks m ust include know ledgeable banking and business leaders, since one of the regional B ank s major functions is to work jointly with and through m em b er com m ercial banks in providing financial services to business, governm ent, agriculture an d the district econom y. In practice, this has m ean t that they have not b een specifically representative of the interests of consum ers, organized labor, minorities, or w o m en how ever those interests m ay be defined. But this is in process of change. R ecen t P ro p o s a ls Several suggestions for reform of the Federal Reserve System have b een proposed, so m e of w hich seem acceptable, even if not offering substantive im provem ents. Collectively, they might en h a n ce the public s understanding of the Federal Reserve as a public institution and its functioning as the su p rem e court of m onetary policy. Among the recent proposals are: The term of the chairm an of the Federal Reserve Board should be coterm inous with the p resid en t s. Som e have suggested that a six or twelve-month overlap would be w ise an d in the interest of stability, allowing a new president to be deliberate in selecting a new chairm an. Others note that the current procedure h as not caused problem s an d m ay have merits worth preserving. There sh o u ld be broader representation am o n g district Bank directors. This proposal seem s desirable an d in keeping with a legitim ate concern for the interests of consum ers an d minorities. Historically, educators and farm er-ranchers have been well represented on the Minneapolis Bank s Board of Directors. Expand ing the n um ber of board m em b ers a proposal that w as m ade last y ear would m ake it possible to ad d persons with a broader range of backgrounds an d experience without losing the contributions of present representation. The m em ber bank stock arrangem ent sh o u ld be eliminated. This suggestion would seem to have little material effect. It m ay now be regarded as an incidental asp ect of m em bership, thought useful at the time the Federal Reserve Act w as enacted. It is not an essential m echanism for Federal Reserve m em bership, but a useful one and certainly not harmful in symbolizing the stake an d the participation that com m ercial banking h a s in the central bank process. Digitized for FRASER 8

11 In contrast, the issue of Federal Reserve m em bership is of major significance. Both equity an d efficiency require that com peting financial institutions be subject to broadly similar reserve requirem ents. This issue b eco m es m ore im portant as other non-bank financial institutions (such as savings an d loans) expand their role. There sh ould be fuller d iscu ssio n s of policy deliberations an d m ore im m ediate reporting of FOMC policy decisions an d plans. This recom m endation h as m uch broader significance. More public know ledge an d discussion of Federal Reserve policy would lead to a m ore informed public and m ore sophisticated understanding of the issues. Clearly a desirable result. At the sa m e time, reforms should not destroy the freedom of policy m akers to explore and discuss all policy options without the inhibiting influence of exposure to public m isinterpretation or criticism during the formulative process. There sh o u ld be full an d frequent reporting to Congress of policy actions an d expectations. This proposal would seem to be helpful to all concerned. The current procedure of regularly reporting to Congress on the targets of m onetary growth has b een generally constructive. Time an d experience with this procedure m ay suggest w h eth er m ore detailed reporting w ould be useful. I n s u la tio n... h o w it w o rk s Being in d ep en d en t within the governm ent m ean s a m onetary function that is insulated from, yet fully aw are of, other essential n eed s such as national defense, foreign policy and trade, resource d e v e lo p m e n t, h o u sin g, a n d e m p lo y m e n t. C o n stru ctiv e policy d eriv es from a structure w hich c an b e both coordinative an d in d ependent, within governm ent an d also beyond governm ent. It will b e helpful, then, to exam ine such co o p erativ e/in d ep en d ent relationships betw een the Federal Reserve System and the other elem en ts with which it m ust coordinate. T hese include: a. T h e e x e c u tiv e b ra n c h, in clu d in g th e p re s id e n t a n d his advisors, the Treasury D epartm ent an d other agencies. b. The Congress. c. Banking an d private financial institutions. d. Structural relationships within the Federal Reserve System itself. With th e E x ecutiv e B ran c h In d ep en d en ce from the executive branch of governm ent w as a main concern during the developm ent of the Federal Reserve System, as it has b e e n since. Yet it is essential that the m onetary function work in cooperation with the president an d his econom ic advisors an d with the m ajor agencies of the executive branch, principally the Treasury D epartm ent. Given the pow er an d influence of the presidency, that office can exert strong pressure and influence on any agency. By an d large, 9

12 presidents h ave b een careful not to a b u se this power, respecting the n eed for an in d ep en d en t m onetary authority. Following World War II it ap p ears that President Trum an did, for a time, support the Treasury D epartm ent in its need to finance the public debt and approved the then subordinate role of the Federal Reserve System in supporting that effort. W hen this im passe w as resolved, the Federal R eserve s responsibility and accountability for m onetary actions w ere restored. Since then, the in d ep en d en t relationship b etw een the two agencies has functioned well. There are an y num ber of linkages betw een the Federal Reserve an d the econom ic ag encies of the executive branch. They are formal and informal and they function at both the policy and staff levels. The chairm an of the Board of Governors, for exam ple, joins the Secretary of the Treasury, the chairm an of the Council of Economic Advisors, and the director of the Office of M anagem ent an d Budget in m eetings of the so-called Quadriad. W hen the Federal Open Market Committee takes policy actions w hich it believes to be in the best interest of the nation, it does so with full know ledge of the adm inistration s plans an d objectives. Chairm an. Federal Reserve Board of Governors Quadriad C hairm an, Council of Economic Advisors Secretary of the Treasury Director of the Office of M anagem ent an d Budget lo

13 Neither the Treasury nor the Board of Governors should be subordinated to the other. It is vitally necessary, however, that m onetary policy, fiscal policy, a n d all the other econom ic policies of the governm ent should be coordinated so that they will m ake a m eaningful whole, working in the direction of price stability, highlevel em ploym ent, a n d a dynam ic, free-enterprise economy. from the congressional S ubcom m ittee of the Joint Com m ittee on the Econom ic Report, A n d th e T re a s u ry The central b an k is in constant contact with the Treasury Departm ent which, am ong other things, is responsible for the m anag em en t of the public d eb t and its various cash accounts. Prior to the existen c e of th e F ed eral R eserve S ystem, the Treasury actually carried out m any m onetary functions. And even since, the Treasury h as often b een deeply involved in m onetary functions, especially during the earlier years. At the beginning of World War 11, it ap p eared desirable that the Treasury be able to issue debt at relatively low interest cost an d also on a b a sis th a t a s s u re d p u rc h a s e rs th a t s e c u ritie s w o u ld b e m arketable at near face value. B ecause of the urgency of this need, the policy w as agreed to and continued after the w ar until During this period, the Treasury w as, in effect, deciding the m onetary policy of the country as it m ad e its decisions as to how m uch debt n eed ed to be funded. B ecause the central bank supported the m arket for governm ent securities, it w as forced to purchase am ounts of securities n ecessary to m aintain low interest rates and the par value of securities. Thus, as the Treasury issued additional debt, the central bank w as forced to acquire part of that debt. This process resulted in direct addition to b an k reserves. Following th e acco rd b e tw e e n th e T reasury a n d the Federal Reserve System, the central b an k w as no longer required to support the securities m arket at any particular level. In effect, the accord established that the central bank would act independently and exercise its ow n judgm ent as to the m ost appropriate m onetary policy. But it would also work closely with the Treasury and would be fully inform ed of a n d sy m p a th e tic to th e T reasu ry s n e e d s in m anaging an d financing the public debt. In fact, in special circum stances the Federal Reserve w ould support financing if unusual conditions in the m arket c a u sed an issue to b e poorly accep ted by private investors. i i

14 The Treasury an d the central bank also work closely in the Treasury s m an ag em en t of its substantial cash p ay m en ts and withdraw als of Treasury Tax an d Loan account balan ces deposited in com m ercial banks, since th ese cash flows affect bank reserves. With th e C o n g re s s A seco n d major relationship, of course, is with the Congress the branch of governm ent that specifically delegated, in the form of the Federal Reserve Act, the responsibility for m anaging m onetary policy in the interests of the nation. At the sa m e time, Congress retained responsibility for the taxing an d spen d in g decisions of the federal governm ent. W hen the b alance b etw een spending an d taxation results in governm ent deficits, the Treasury h as to issue additional public debt. In a m onetary sen se, the failure to tax adeq u ately to cover the expenditures of the Federal governm ent is an invitation for printing m o n ey through the issuance of federal debt. D epending on the p h ase of the business cycle, this tends to increase the m oney supply and, w ithout offsetting action by the central bank, can result in an inflationary rise in prices. The result is hidden taxation which takes aw ay from taxpayers in the form of lower purchasing pow er (higher prices) w hat they would h ave paid in additional taxes had the ex p en d ed funds b e e n obtained through that source. Thus there is an im portant linkage b etw een the taxing and sp en d in g pow ers of Congress a n d the m onetary pow ers as delegated to the Federal Reserve System. In principle, it is the job of Congress an d the executive branch jointly to define the econom ic policy objectives of our national governm ent, and to support those objectives with appropriate fiscal m easures. Then the central bank can coordinate m onetary policy in a m an n er w hich serves those national objectives. W hen fiscal policy does not m atch spending appropriately to tax revenues, then the m onetary authority is faced with a difficult choice: (a) how severely should it restrain the inflationary forces that m ay develop, an d (b) to w hat extent should it perm it inflationary forces to h av e their effect in higher prices? W hen the failure to provide appropriate tax rev en u es g en erates acute forces of inflation, then even the best com prom ise m ay require sev ere m onetary restraint. This h a s the effect of appearing to be at cross-purposes with congressional intent an d can also produce severe disruptions in som e areas of the private sector such as housing. Thus, the Congress and the Federal Reserve System m ay not alw ays ap p e a r to agree in their policy actions, but they have a su b stantial com m on interest in coordinating such policies. Monetary policy can be less extrem e w h en fiscal policy is doing its share. A nother reason for delegating the m onetary responsibility to an authority not directly a part of the governm ent is the high degree of 12

15 technical expertise required to analyze econom ic data, trends, and other information related to appropriate m onetary decisions. While the Federal Reserve h as b e en called the m onetary a g en t of Congress and is subject to its ultimate control, its special responsibilities require a separation in carrying out its unique functions. Congress cannot effectively legislate day-to-day m onetary decisions, nor even provide operating m andates. In the dialogue betw een the Congress and the central bank, both the intent of the national policy an d the rationale for appropriate m onetary policy m ust be com m unicated. To accom plish this, the Federal Reserve System reports regularly to the Congress with regard to its conduct of m onetary policy. Over the years, exhaustive h earin g s h a v e b e e n held by the S e n a te a n d H ouse b an k in g com m ittees regarding the functions an d procedures of the Federal Reserve System. The Joint Economic Com m ittee an d other com m ittees of Congress frequently call on Federal Reserve representatives to discuss both policy an d operational matters. With B a n k in g A third area of in d ep en d en ce relates to com m ercial banking and other private financial institutions. It w as no accident that the Federal Reserve System w as struc tured to include direct representation from com m ercial banking, for without a sound banking system m onetary policy could not operate. W hen the central bank takes action to restrict or expand the m oney supply, the multipliers set in motion are leveraged through the banking sy stem often to the discomfort of bankers them selves. W hen m onetary policy is restrictive, the restrictive action takes place at the loan d esk s of com m ercial banks w here, with greater d em an d for funds and limited m oney to lend b ecau se of the restrictive policy, ban k ers are forced to decline so m e loans that both they an d their Congress, recognizing that restrictive m onetary policies m u st som etim es be strongly stated to control inflation, h a s chosen to endow the System with a considerable degree of independence. But under the Constitution this independence can never rise above the relationships of a faithful an d trustworthy servant a n d a responsible, watchful master, in this case the Congress. R epresentative Wright Patm an,

16 custom ers might otherwise consider prudent. Thus is expansion of the m oney supply restrained. All national banks and m any state-chartered b an k s are m e m bers of the Federal Reserve System. It is essential that the majority of bank deposits in the country be subject to Federal R eserve requirem ents in order that the reserve m ech an ism s for controlling the m oney supply can function well and equitably. In addition, the central bank is charged to perform other services for m em b er banks such as supplying coin and currency, clearing checks, transferring funds, an d m aking loans to m em ber b an k s under special circum stances. T hese services require direct working relationships with com m ercial banks. The Federal R eserve s supervisory role (and also the central b an k s ultimate role as the lender of last resort) reflects both the public need and the m onetary n eed for so und banking. Through all these close ties and relationships, it is essential that the central bank deal at arm s length with com m ercial banking in general an d that it not be dom inated or m a d e subservient to banking interests. This also has been a major concern of Congress over the years and is a concern that is reflected in its design of the Federal Reserve Act. It is one of the reasons w hy the Federal R eserve s bank supervision an d regulatory functions are structurally accountable to the Federal Reserve Board rather than to regional b an k boards. W ithin Itself One other area in which sep arateness an d in d ep e n d e n ce have significant m eaning is within the Federal R eserve System itself. As originally conceived, the regional Federal Reserve Banks w ere largely autonom ous: a federation of regional institutions m ad e up the Federal Reserve System. As time an d experience brought changes, it b ecam e necessary to coordinate m onetary policy on the national level, while continuing to perform central bank services for m em b er banks, including the discount (lending) function at the regional level. Regional Federal Reserve banks are regularly exam ined by the Board of Governors to confirm the internal quality an d integrity of each Bank s operations and also to en su re that regional Banks are com plying with all statutory regulatory requirem ents of the System. An im portant feature within the Federal Reserve is that the chairm an of the Board of Governors, though sp o k esm an for both the seven-m an Board and the Federal Open Market Committee, d oes not have in d ep en d en t authority. He cannot establish policy himself nor control policy decisions. He is subject to an d limited by the majority vote of the councils of which he is part. Thus, there exists within the System itself ch eck s an d balan ces w hich limit the authority and the pow er of its different elem ents. T hese relationships are significant w h en structural c h an g es are u nder consideration. 14

17 The Board subm its regular a n d frequent reports to C ongress on economic data and financial matters. Indeed, the detail in which financial data are p ublished is greater than for any other central bank in the world. Arthur Burns, congressional testim ony in January P e rs p e c tiv e s o n In d e p e n d e n c e Our central b an k structure functioning in an environm ent reaso n ably insulated from the day-to-day pressures of partisan politics and short-term ex p ed ien cy w as born out of d e cad es of experience with b o o m /b u st recessions, financial panics, an d m onetary instability. Over the years, the System and its vital m onetary function have b e e n u n d er co n stan t scrutiny and review by Congress, by professional econom ists, by banks and financial experts as well as by the public. Hearings by S enate and House banking com m ittees on F e d e ra l R e se rv e resp o n sib ilities a n d p ro c e d u re s h a v e b e e n exhaustive. Such studies h av e produced innum erable ch an g es in responsibilities, authority an d procedures. It is through su ch efforts that our m onetary m ech an ism s have kept pace with the changing n eed s of the times. While m any problem s persist, it is also true that over the p a st th re e d e c a d e s an d d esp ite so m e pretty difficult tim es recessions h av e b e en m oderate, and severe panics and disruptions h av e b een largely avoided. W hether the proposals currently suggested are useful rem ains to be seen. But the role of the Federal Reserve System in carrying out the exacting responsibilities of m anaging the nation s m onetary policy req u ires th e b est structural an d p ro cedural fram ew ork p o ssib le to d o that job. The record su g g ests th at a d e g re e of in d e p e n d e n c e is essential for effective execution of its m onetary role. There is a recognized need for professionalism in analysis and formulation of policy free of partisan/expediency considerations an d free of distraction from other responsibilities. Urgent an d changing econom ic needs call for frequent review, evaluation, a n d suggestions for reform relying on the tested lessons of past ex perience a s w e learn to understand an d cope with new ch an g es. 15

18 A System that provides responsible policy m ust serve the broad public interest, rem aining objective a n d rem oved from special interest, yet ultimately accountable to a n d in dialogue with the realities of changing times, hum an values, an d econom ic conditions. President *Robert w. Worcester, vice president at the Federal Reserve Bank of Minneapolis, provided valuable assistance in preparing this text for publication. 16

19 1976 in Review Each y ear the Bank develops a set of objectives to identify those efforts w hich, in the judgm ent of m anagem ent, constitute the B ank s m ost im portant n ew undertakings for the com ing year. As a part of this process, a m ore detailed structure of sub-objectives is developed by the various d epartm ents of the Bank w hich directly supports th ese m a n ag e m e n t level priorities and in other w ays contributes to the B ank s longer-term m issions identified in its statem en t of goals. Over the past few years, our bank objectives have focused increasingly on the efficiency and effectiveness of internal op erations: in four of five Bank objectives w ere internally oriented. This em p h asis reflects the System s determ ined effort to m ake Federal R eserve Banks both efficient and productive in keeping with the b est applications of good m an ag em en t and available technology. S u ch co n sid eratio n s m ust alw ay s be w eig h ed again st service n e e d s of the financial com m unity, our role in serving the public interest as the nation s central bank, and our responsibilities for setting national m onetary policy. The stated Bank objectives for 1976 and a sum m ary review of ach iev em en t are set forth below. To limit the increase in total net controllable expensesfor to 8 percent above net controllable expenses in This objective w as achieved as net controllable expenses in w ere 7.2 percent above net controllable expen ses in Net controllable ex p e n se s are those costs rem aining after excluding cost item s over w hich m an ag em en t has very limited short-run control (e.g., real estate taxes, building depreciation, new currency costs, etc.). This w as accom plished in spite of increasing costs, normal volum e increases w hich w ere approximately 7 percent above 1975 levels, and new responsibilities in som e functions such as increased activity related to consum er protection legislation. The prim ary offset to th ese factors w as the continuing effort on the part of the Bank to hold the line on ex p en ses through productivity and efficiency in the various operating an d support areas, mainly by im proved technology and procedures. Contributing to this continuing effort h a s b een the developm ent of m an ag em en t talent and tools. Salary ex p en ses, which constitute over 5 0 percent of controllable ex p en ses, increased by 7.3 percent exactly the figure projected. The total Bank staff declined just slightly for the year. 17

20 To com plete scheduled deuelopm ent a n d im plem entation of the new Federal Reserve Planning a n d Control System (PACS)at M inneapolis an d Helena. The new Federal Reserve Planning an d Control System is designed to facilitate planning, budgeting, an d e x p en se control throughout the Federal Reserve System, in efforts w ere directed to the developm ent and im plem entation of the internal ex p en se accounting and reporting com ponent of the system. In addition to providing better internal expense and b udget information for Bank an d line m anagem ent, the new system will also provide im proved com parability am ong Reserve Banks for ex p en se an d productivity data. The expen se accounting and reporting co m p o n en ts h av e b een im plem ented during and began fully functioning on January l of D evelopm ental work on the entire Planning an d Control System will continue through To rank above the first quartile in all currently m onitored production a n d cost areas according to the a n n u al System ranking, while allowing no deterioration of System ranking in those areas representing l.o percent or m ore of total controllable costs. B ecause of the unique nature of our central b an k operations and functions, m any of the com m on w ays of m easuring organizational achievem ent profit, share of market, or return on equity are not available to us. Thus, w e look to other m easu res an d stan d ard s as proxies to asse ss our operational effectiveness. One of th ese is by com paring our efficiency and productivity with the other 1 1 Federal Reserve Banks, all of w hom are providing essentially the sam e kinds of services. At the en d of the Bank s perform ance, in five of so m e two dozen operational areas in which w e can b e co m p ared with other Reserve Banks, show ed that w e ranked in the low est quartile tenth, eleventh, or twelfth in term s of either productivity or cost. Our objective w as to concentrate on im provem ent in those areas w here relative m easu res indicated most im provem ent w as needed, while experiencin g no deterioration in p erfo rm an ce else w h e re. Information available in January 1977 indicates that our objective w as achieved in four of the five areas. To develop an d im plem ent a com prehensive training a n d developm ent program for Bank officers a n d staff which will set guidelines for participation in various types of developm ental program s. During our efforts toward this objective focused principally upon developing an operating fram ew ork for an integrated staff d ev elo p m en t an d training program o n e that h elps us identify Digitized for FRASER 18

21 B ankw ide training and developm ent n eed s an d also the best vehicles to m eet those needs. T his fra m e w o rk o u tlin e s th e v ario u s lev els a n d ty p e s of d e v e lo p m e n t p ro g ram s an d their relationship to the identified training needs. While full developm ent of the total program outlined will extend into an d beyond, a num ber of im portant elem ents w ere im plem ented in These include in-house supervisory and m a n a g e m e n t training, presentational speaking, and better use of various m a n a g e m e n t schools. During the y ear w e com pleted the com prehensive redesign of our job evaluation structure and procedures, including a com pletely n e w se t of jo b d e sc rip tio n s, n ew g ra d e stru c tu re s, a n d final reevaluation of all non-official jobs. Our Bankw ide perform ance review program, an d formalization of job-posting procedures, w ere also modified during the year. To com plete research studies identifying public policy problem s relevant to the Ninth District an d developing p ro p o sals for a c tio n s to c h a n g e law s of regulative p ro ced u res affecting: (a) E F T s y s t e m s d e v e lo p m e n t th ro u g h o u t th e D istrict, (b) state banking structure an d perform ance (Minnesota only, this year) a n d (c) risk exposure and contingency p rep ared n ess of larger ban k s in the District. in general, the studies done in furtherance of this objective have provided the public an d this Bank with a basis for evaluating current public policy issues. Four background studies in the area of electronic funds transfer (EFT) w ere produced by various departm ents of the Bank during 1976: 1. A Survey of Significant EFT D evelopm ents in the Nation a n d the Ninth Federal Reserve District 2. EFTS: Public Policy Issues 3. C o m p e titiv e A s p e c ts of E le c tro n ic F u n d s T r a n s fe r System s 4. L egal D im en sio n s of E lectronic F u n d s T ran sfer in th e Ninth District E x e r p ts fro m th e first tw o s tu d ie s w e r e p u b lis h e d in the Ninth District Quarterly and the first paper w as published in full as part of our EXPONENT series, entitled, Electronic F unds Transfer: The Future is Now. A condensed version of the third pap er exam ining ch a n g e s in the com petitive relationships am ong financial institutions that m ay result from EFT system developm ents is sched u led for publication early in The fourth study rem ains an internal working docum ent. Two studies on state banking structure are being published early in T he first The Philadelphia National Bank Case Revisited 19

22 review s the analysis used by the S uprem e Court in its landm ark decision (1973) concerning the Philadelphia National Bank. A key asp ect of that decision w as that com m ercial banking w as considered a distinct line of com m erce. The appropriateness of this definition, b ased on a type of institution rather than a type of service offered, is looked at in light of the changing environm ent in w hich financial institutions are increasingly com peting across traditional lines. The second study is a follow-up to an earlier publication by this Bank w hich characterized M innesota s banking structure as ex cep tional. This follow-up, which takes into account a broader array of financial institutions in the state, and a com parison with different states, generally finds that the structure of financial institutions in M innesota is not exceptional if com pared with states w h ere branch banking is permitted. Over the past two years w e have b een in touch with the larger Twin Cities banks concerning contingency plans for dealing with possible runoffs of interest sensitive funds. A form w as devised and tested by a num ber of these banks that w ould show the exposure of the bank to such runoffs under various hypothetical situations. Variations of this contingency approach h ave b een ad o p ted by som e Twin Cities banks. Operational Highlights In addition to the progress achieved on special Bankw ide objectives, other operational and staff developm ents are sum m arized below. Gross earnings of the Minneapolis Federal Reserve Bank for 1976, consisting mainly of interest on U.S. G overnm ent an d Federal ag en cy securities, w ere $ million, up $ million from Net total ex p en ses w ere $ 2 6 million in 1976, up 9.2 percent. This includes an increase of $ 8 0 7,0 0 0 in the cost of printing Federal Reserve currency. The statutory 6 percent dividend paid to m em b er banks on their required holding of Reserve Bank capital stock totaled $ 1,643,000. The Bank s surplus w as increased by $ 2,4 9 7,0 0 0, an d the b alance of net earnings, $ million, w as paid to the United States Treasury as interest on Federal Reserve Notes. Conventional check volum e at M inneapolis increased 6 percent, from million items in to million item s in , averaging about two million checks each working day. Efforts to cope with this growing volum e include continued autom ation of the check clearing process an d step s to reduce the growth of ch eck s as a m e a n s of m oney transfer. 20

23 During the Regional Check Processing Center at our Bank w as e x p a n d e d to include an additional 41 Wisconsin banks. It now includes all b anks within a 7 5 mile radius of Minneapolis, plus major cities such as Eau Claire, La Crosse, Rochester, Austin, Willmar, St. Cloud, Duluth, an d Superior. More than 7 0 percent of the dollar volum e of ch eck s draw n on banks in the Minneapolis territory are eligible for im m ediate (sam e day) credit to the depositing bank. The Duluth Regional Check Clearing Arrangem ent, com m only called the Duluth Plan, w as in operation for the full year 1976, handling an averag e of 2 0,0 0 0 items per day w hich w ere formerly p rocessed at the Minneapolis Fed. The Duluth Plan, including the Iron R ange an d northw estern Wisconsin, now serves about 5 5 banks. A utom ated clearing house (ACH) operations in saw further e x p a n s io n in b o th c o m m ercial en trie s a n d F e d e ra l recu rrin g paym ents. In the latter category, Social Security p aym ents and several other sm aller program s w ere ad d ed to our initial program of processing Air Force payrolls. District-wide distribution of the new $2 currency denom ination w as initiated early in the year as part of the national effort to re-institute the u se of the $2 denom ination. The objective is to reduce the total n u m b er of bills in circulation with com m ensurate reductions in printing an d handling costs. The Treasury D epartm ent is considering other ch a n g es in coin denom inations and usage that m ay further en co u rag e $2 bill usage. Minting of bicentennial-designed q u arters, half-dollars, an d dollars, first issued in 1975, will be discontinued in Overall currency and coin volum e increased during 1976 by roughly l o percent for currency handling and by 14 percent for coin. The volum e of Treasury securities issues and redem ption rose m arkedly during reflecting the major increase in Treasury financing over the past two years. The dollar volum e of issues redem ption an d exchanges roughly doubled over 1975, an d the n u m b er of transactions w as up one-fifth. Late in the year, the Treasury D epartm ent began issuing 52- w eek Treasury bills on a book-entry-only basis. This significant step will b e ex ten d ed to other bill issues in 1977 and eventually to other types of Treasury securities. With the growing complexity of consum er-related regulations, the Bank h a s had to increase its efforts to provide information to co n su m ers an d others about such regulations. Bank representatives spoke to approxim ately l,8 0 0 people on the Equal Credit Opportunity Act, Fair Credit Billing Act, and The Federal Trade Com m ission s Holder in-due C ourse Regulation. Our c o n su m e r specialists also an sw ered telephone inquiries from bankers an d investigated all co n su m er com plaints involving state m em ber banks. Late in two experim ental m eetin g s w ere held with m em b er b an k ers in Michigan an d Wisconsin to (a) u p d ate m em ber 21 Digitized for FRASER

24 banks on recent developm ents in Reserve Bank services and program s, an d to (b) provide a forum for b ankers to express their views, suggestions, and criticisms about Fed operations an d services. T hese m eetings, which w ere d eem ed productive, will b e continued in Our series of informational conferences for bank directors (started in 1974) w as continued in 1976 with m eetings in Rapid City an d Sioux Falls. Similar conferences are p lan n ed for

25 F e d e ra l R e s e rv e B a n k o f M in n e a p o lis F in a n c ia l S ta te m e n t S ta te m e n t o f C o n d itio n (In T h o u san d s) D ecem ber A ssets Gold Certificate Account... $ 22 1,457 Interd istrict Settlem ent F u n d ,951 Special D raw ing R ig h ts Certificate Account... 24,000 Federal Re se rve Notes of Other Federal Rese rve B a n k s... 26,922 Other C a sh... 13,863 Lo a n sto M e m b e rb a n ks... S e c u ritie s... Federal Agency Obligations ,333 U.S. G overnm ent S e c u ritie s... 2,132,514 To ta l Se c u ritie s... 2,287,847 Cash ite m sin P ro c e sso f C ollection ,022 B a nk P re m ise s N e t... 30,939 Other A sse ts... 43,01 l To ta l A s s e t s... $3,332,0 12 Liabilities Federal Re serve N o te s... $ l,749,458 Deposits Member B a n k Reserve A c c o u n ts ,185 Due to Other Federal Reserve Banks-Collected F u n d s... 42,337 U.S. Treasury-G eneral Account ,245 Fo reig n... 6,600 Other D e p o s its... 19,657 To ta l D e p o sits... l,0 7 1,024 Deferred A va ila b ility Cash It e m s ,483 O th e rlia b ilitie s ,867 To ta l L ia b ilitie s... $3,274,832 CMpital A ccounts Capital Paid I n... 28,590 S u r p lu s... 28,590 To ta l Capital... 57,180 To ta l Lia b ilitie s and Capital A c c o u n ts... $3,332, $ 205, ,139 10,000 43,486 15, , ,619 1,894,025 2,026, , ,399 33,044 $3,208,756 $ 1,586, , ,412 6,302 5,246 1,086, ,747 25,106 $3,156, ,186 $3,208,756 23

26 E a rn in g s a n d E x p e n s e s (In T h o u s a n d s ) For the Year E n d ed D ecem ber Current Earnings Interest on Lo a nsto Member B a n k s... S 173 $ 2 17 Interest on U.S. Government Securities and Federal Agency O b lig a tio ns , ,326 A llo th e re a rn in g s To ta lc u rre n te a rn in g s , ,890 Current E xpenses Salariesand Other B e n e fits... 14,782 13,171 Postage and Exp re ssa g e... 2,845 2,702 Te lephone and Te le g ra p h Printingand S u p p lie s Real Estate T a x e s... 1,587 1,500 Fu rn itu re and Operating Equipm ent P u r chases, Rentals, Depreciation, Maintenance.. 1,879 1,950 Depreciation Ba nk P re m is e s... 1,566 1,566 U t ilit ie s Other Operating E x p e n s e s... 1,532 1,827 Federal Reserve C u rre n c y... 1, To ta l Current E x p e n s e s... 27,486 25,1 12 E xp e n se s Reim bursable or Recoverable. ( 1,437) (1,31 7) N e texp e n se s... 26,049 23,795 Current Net Earnings , ,095 Net Profit (or L o s s ) (4,9 18) A sse ssm e n t for Exp e n se s of Board of G overnors... ( 1,1 76) (818) D ivid e nd s P a id... ( 1,643) (1,387) Paym ents to U.S. Tre a su ry... ( 1 14,37 1) (97,610) Tra nsfe rre d to S u rp lu s... 2,497 4,362 Su rp lu s, January , ,731 Su rp lu s,d e c e m b e rs l... $ 28,590 $ 26,093 V o lu m e o f O perations* Number Dollar A m ount For the Year Ended December ;i I 197( L o a n sto M e m b e rb a n k s $ million $ million C urrency Received an d Verified. 145 million 12 8 million l.l billion million C o in R e c e iv e d a n d C o u n te d million 481 million 7 5 million 7 0 million C hecks H andled, T o ta l million million 177 billion 160 billion Collection Item s H a n d le d....3 million.4 million 1.4 billion 1.3 billion Issues, R edem ptions, E xchanges ofu.s.g overnm entsecurities million 7.6 million billion billion Securities Held in S a fe k e e p in g , billion 8.0 billion T ransferof F u n d s , , billion billion 'M i n n e a p o l i s a n d H e l e n a c o m b i n e d 24

27 Directors of the Federal Reserve Bank of Minneapolis Jan u ary Term expires D ecem ber 31 of indicated year Jam e s P. McFarland, Chairman and Federal Reserve Agent S tep h en F. Keating, Deputy Chairman C lass A Elected by Member Banks William E. Ryan, President (1977) Citizens State Bank, Ontonagon, Michigan John S. Rouzie, President (1978) First National Bank, Bowman, North Dakota Nels E. Turnquist, President (1979) National Bank of South Dakota, Sioux Falls, South Dakota C lass B Elected by Member Banks Donald P. Helgeson, Secretary-Treasurer ( 1977) Jack Frost, Inc., St. Cloud, Minnesota Russell G. Cleary, Chairm an an d President (1978) G. H eilem an Brewing Com pany, Inc., La Crosse, Wisconsin W arren B. Jones, Secretary-Treasurer (1979) Two Dot Land & Livestock Com pany, Harlowton, Montana C lass C A ppointed by Board of Governors S tep h en F. Keating, Chairm an (1977) Honeywell, Inc., Minneapolis, Minnesota Jam e s P. M cfarland, Chairm an (1978) G eneral Mills, Inc., Minneapolis, Minnesota Charles W. Poe, Jr., President (1979) Metropolitan Econom ic Developm ent Association (MEDA) M inneapolis, M innesota M ember of Federal Advisory Council Richard H. V aughan, President N orthwest Bancorporation, Minneapolis, Minnesota Directors of the Helena Branch Patricia P. Douglas, Chairm an Norris E. Hanford, Vice Chairm an A ppointed by Board of Directors Federal Reserve Bank of M inneapolis Donald E. Olsson, President (1977) Ronan State Bank, Ronan, Montana William B. A ndrew s, President (1978) N orthw estern Bank of Helena, Helena, Montana George H. Selover, President & General M anager (1978) Selover Buick-Jeep, Inc., Billings, Montana A ppointed by Board of Governors Norris E. Hanford, in dependent grain operator (1977) Fort Benton, M ontana Patricia P. Douglas, Assistant to President and Professor ( ) University of M ontana, Missoula, Montana 25

28 Officers of the Federal Reserve Bank of M inneapolis J a n u a ry Bruce K. MacLaury, President Clem ent A. Van Nice, First Vice President Thom as E. Gainor, Senior Vice President Roland D. Graham, Senior Vice President John A. MacDonald, Senior Vice President Melvin L. Burstein, Vice President and General Counsel Frederick J. Cramer, Vice President Leonard W. Fernelius, Vice President Lester G. Gable, Vice President Bruce J. Hedblom, Vice President Douglas R. Hellweg, Vice President Howard L. Knous, Vice President and General Auditor David R. McDonald, Vice President Clarence W. Nelson, Vice President an d Director of Research Robert W. Worcester, Vice President Sheldon L. Azine, Secretary and Assistant Counsel Earl O. Beeth, Assistant Vice President Jam es u. Brooks, Assistant Vice President Phil C. Gerber, Assistant Vice President Gary P. Hanson, Assistant Vice President Richard C. Heiber, Assistant Vice President William B. Holm, Assistant Vice President Ronald E. Kaatz, Assistant Vice President Michael J. Pint, Assistant vice President an d Assistant Secretary Ruth A. Reister, Assistant Vice President an d Assistant Counsel Charles L. Shromoff, Assistant Vice President Colleen K. Strand, Assistant Vice President Richard B. Thom as, Assistant Vice President Joseph R. Vogel, Chief Examiner Officers of the Helena Branch John D. Johnson, Vice President Ronald O. Hostad, Assistant Vice President Betty J. Lindstrom, Assistant Vice President 26

29 F o r additional copies: Office of Public Inform ation Federal Rese rve B a n k of Minneapolis M inneapolis, M innesota 55480

30 Illustrations a d a p te d with p erm issio n of the N ational G eographic Society Digitized for FRASER