Chapter 9
Central Banks
and the Federal Reserve System
Origins of the Federal Reserve System
Inside the Fed Box: The Political Genius of the Founders of the Federal Reserve System
Structure of the Federal Reserve System
Federal Reserve Banks
Inside the Fed Box: Special Role of the Federal Reserve Bank of New York
Member Banks
Board of Governors of the Federal Reserve System
Inside the Fed Box: Role of the Research Staff
Federal Open Market Committee (FOMC)
Why the Chair of the Board of Governors Really Runs the Show
Inside the Fed Box: The FOMC Meeting
Inside the Fed Box: Green, Blue, Teal, and Beige: What Do These Colors Mean at the Fed?
Why the Chairman of the Board of Governors Really Runs the Show
Inside the Fed Box: How Bernanke’s Style Differs from Greenspan’s
How Independent Is the Fed?
Should the Fed Be Independent?
The Case for Independence
The Case Against Independence
Central Bank Independence and Macroeconomic Performance Throughout the World
Explaining Central Bank Behavior
Inside the Fed Box: The Evolution of the Fed’s Communication Strategy
Structure and Independence of the European Central Bank
Differences Between the European System of Central Banks and the Federal Reserve System
Governing Council
How Independent is the ECB?
Structure and Independence of Other Foreign Central Banks
Bank of Canada
Bank of England
Bank of Japan
The Trend Toward Greater Independence
Chapter 9: Central Banks and the Federal Reserve System 45
◼ Overview and Teaching Tips
As a first step in learning about the conduct of monetary policy, the student needs to understand how
the central bank in the United States—the Federal Reserve System—operates. The basic point that should
be driven home in class is that although the Federal Reserve System has a complicated bureaucratic
structure, in practice, it functions like a single central bank, headquartered in Washington, D.C. Students
should enjoy the discussion of how foreign central banks are structured and how foreign central banks are
similar or differ from the central bank in the United States.
To help the instructor spice up the discussion of the Federal Reserve, I try to provide an inside view of
the Fed by including material on such topics as the political genius of the way the Federal Reserve was
set up to preserve its independence, the special role of the Federal Reserve Bank of New York and the
research staff in the Federal Reserve System, the role of member banks, how a typical FOMC meeting
is conducted, how Ben Bernanke’s style differs from Alan Greenspan’s, and how the Fed’s
communication strategy has evolved over time. To feature this new material I have included some of it in a
set of special interest boxes, titled “Inside the Fed,” which provide insights on how the Federal Reserve
System operates although they are based on information that is entirely in the public domain.
Until recently, the Federal Reserve had no significant rivals in the central banking world. This changed in
January 1999 with the startup of the European Central Bank (ECB), which now conducts monetary policy
for countries that are members of the European Monetary Union, which in total have a population that
exceeds that of the United States and a GDP comparable to that of the United States. Because of growing
interest by students in the workings of the European Central Bank, the chapter has an extensive discussion
of the structure and independence of the European Central Bank. To motivate this material, I focus on how
the ECB is similar to the Federal Reserve and how it differs. The chapter also contains brief descriptions
of the structure and independence of three other important central banks of interest to students: the Bank of
Canada, the Bank of England and the Bank of Japan.
Students seem particularly to enjoy the discussion of the theory of bureaucratic behavior and the related
issue of whether or not central banks should be independent. Thus I recommend focusing on these topics,
rather than the detail of the Fed’s structure, which can be tedious.
In addition to the institutional detail on the Fed that is usually found in financial markets and institutions
textbooks, this chapter also tries to provide the student with a feel for what motivates the Fed and other
central banks. Furthermore, discussing the theory of bureaucratic behavior shows students that the
economic way of thinking is useful in understanding a wider range of problems than they might otherwise
have thought.
◼ Answers to End-of-Chapter Questions
2. The placement of two banks in the Midwest farm belt might have been engineered to placate farmers,
an important voting block in the early twentieth century.
3. Like the U.S. Constitution, the Federal Reserve System, originally established by the Federal Reserve
Act, has many checks and balances and is a peculiarly American institution. The ability of the
46 Mishkin/Eakins • Financial Markets and Institutions, Eighth Edition
Copyright © 2015 Pearson Education, Inc.
groups (professional bankers, businesspeople, and the public) was again intended to prevent any
group from dominating the Fed. The Fed’s independence of the federal government and the setting up
of the Federal Reserve banks as incorporated institutions were further intended to restrict government
power over the banking industry.
4. The Federal Reserve Banks influence the conduct of monetary policy through their administration of
5. The Board of Governors sets reserve requirements and the discount rate; the FOMC directs open
6. The 14-year terms do not completely insulate the governors from political influence. The governors
know that their bureaucratic power can be reined in by congressional legislation and so must still
7. The structure of the European System of Central Banks(ESCB) has many similarities to that of the
Federal Reserve System. The ESCB has an Executive Board that is similar to the Board of
Governors of the Federal Reserve System, a governing council that has a similar function to that of
9. The threat that Congress will acquire greater control over the Fed’s finances and budget.
10. The theory of bureaucratic behavior indicates that the Fed will want to acquire as much power as
possible by requiring all banks to become members. Although the Fed did not succeed in obtaining
11. False. Maximizing one’s welfare does not rule out altruism. Operating in the public interest is clearly
12. Eliminating the Fed’s independence might make it more shortsighted and subject to political
influence. Thus, when political gains could be achieved by expansionary policy before an election,
Chapter 9: Central Banks and the Federal Reserve System 47
Copyright © 2015 Pearson Education, Inc.
the Fed might be more likely to engage in this activity. As a result, more pronounced political
business cycles might result.
13. False. The Fed is still subject to political pressure because Congress can pass legislation limiting the
14. Uncertain. Although independence may help the Fed take the long view, because its personnel are not
directly affected by the outcome of the next election, the Fed can still be influenced by political
15. The argument for not releasing the FOMC directives immediately is that it keeps Congress off the