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October 26, 1984

The idea of a "central bank" in the United States
arose from widespread concern over recurring financial crises and panics early in this century.
Those crises and panics were caused by an "inelasti c" su ppIy ofcu rrency andcred it and the absence
of a central bank that could balance the amount of
money and credit available with the American
economy's abi Iity to produce and consume goods
and services. Theform th is central bank took is the
subject of this Letter.
The authors of the Federal Reserve Act in 1913
conceived of a decentralized central banking system involving a combination of private and public
interests. They created this structure to dispel widespread concern over a concentration of economic
power-in this case, money and credit-in the
hands of either the nation's banks (especially the
large Eastern banks) or the nation's politicians.
At the time, the term central bank, with its connotations of centralized power and .control, was so
unpalatable to segments of the public that it did
not appear anywhere in HR 7837, the Federal
Reserve Act. In the intervening 70 years, we have
come to accept the term as entirely appropriate
given the dramatic expansion of the Federal Reserve System's functions in response to the demands of a rapidly changing and increasingly
complex financial environment. This Letter discusses the principal provisions of the Federal Reserve Act to remind us that the decisionmaking
structure of the System remains decentralized in a
manner that is perhaps unique in American government.
An elated President Wilson signed the Federal
Reserve Act into law on December 23, 1913. His
desire for a decentralized reserve system with a
"balanced" mix of public and private as well as
regional elements, found accommodation in several key provisions of the Act. One was the stipulation that the number of Federal Reserve Districts
be "not less than eight or more than twelve,"
delineated with "due regard to the convenience
and customary course ofbusiness" and "not necessarily coterminous with state lines." Under an
organizing committee headed by the Secretary of

the Treasury, in consultation with representatives
of banks, clearing houses, major industries and
business associations, delineation of the resulting
twelve Federal Reserve Districts occasioned considerable dispute in some sections of the country.
Concern for a proper balance of various interests
was reflected in provisions affecting the structure
and composition of both the Reserve Banks and
the Federal Reserve Board. The "private" element
was represented by the provisions for member
bank stock subscriptions in, and election of, six of
the nine directors of the proposed twelve regional
Federal Reserve Banks. These directors were to
include three bankers (Class A), one each to be
elected by small, medium-sized and large banks,
and three others (Class B) actively engaged in
commerce, agriculture or some other industrial
pursuit (in effect, potential borrowers) who could
not be an officer, director or employee of any
bank. The remaining three (Class C) directors, including the Chairman and Vice Chairman, were to
be appointed by the Federal Reserve Board to
representthe general public; they could not be a
bank officer, director or employee, or own any
bank stock. Thus, the majority of each Reserve
Bank's board would consist of non-bank interests.
In 1977, the basis for selecting Class B and Class C
directors was broadened substantially to include
representatives of labor, consumers, and the service sector. Fu rthermore, the selection was to take
place without discrimination as to race, color, sex
or national origin. A bill recently passed by the
House would add two Class C directors, at least
one of whom must be representative of thrift institutions.
The directors also were empowered to appoint the
Bank's officers and employees and "to dismiss
them at pleasure." At the outset, the Banks began
choosing a "Governor" as the chief executive
officer. In 1935, Congress changed this position to
"President" and subjected selection for this position to formal approval by the Board of Governors.
The Federal Reserve Act provided for stock subscriptions by member banks in part to obviate the
need for government financing. In deference to

the "dual" system offederal and state bank chartering, membership was made compulsory for national banks but voluntary for state banks, while
stock holdings, which cannot be traded in the
market, were (and still are) limited to a statutory
dividend of 6 percent. The Act also stipulated that
in the event that capital subscription by banks
proved inadequate, stock in the Reserve Banks
cou Id be sold to the general pu bl ic, and then to the
Treasury as a last resort. As Congressman Glass,
author ofHR 7837, emphasized, the Reserve
Banks would have "an essentially public character" and, except for purposes ofthe Federal Tort
Claims Act, are "instrumental ities" of the government in the exercise of thei r major responsibi Iities.
Contrary to some assertions, ownership of Federal
Reserve Bank stock does not vest control of the
Reserve Banks (or the determination of System
policies) in memberbanks. The Presidentially appointed Board of Governors must approve the
appointment of Reserve Bank presidents (and may
remove any Reserve Bank officer or director), must
approve any change in discount rates, sets the
ru les under which a Reserve Bank may make advances to depository institutions, and must approve
Reserve Bank budgets under guidelines and limits
which it prescribes. Under guidelines set by the
Congress, it also sets the prices which the Reserve
Banks charge depository institutions for check
clearing and other payments-related services.
The public nature of the Federal Reserve System is
further evident in the fact that after operating expenses and payment of the small statutory dividend
on stock subscriptions, all ofthe System's net earnings are paid to the Treasury. In 1983, these payments (mostly earnings from its open market portfolio and discount operations) amounted to $14.2
bi II ion and represented about 90 percent of the
System's gross intome.

Wilson's "capstone"
In the words of Congressman Glass, the Federal
Reserve Board wou Id represent "the on Iy factor of
centralization in the new System." Specifically, he
envisioned the Board as "an altruistic institution, a
part of the government itself (but) a distinctly nonpartisan organization whose functions are to be
wholly divorced from politics." It would be an
entity created solely for regulating relationships
"between the Federal Reserve Banks and between
them and the government itself.'"

To this end, the Act provided for a seven-member
Board, including, in addition to the Secretary of
the Treasury and the Comptroller, five other members to be appoi nted by the President with the
advice and consent ofthe Senate, with "due regard
to a fair representation of the different commercial,
industrial and geographical divisions of the country." At least two of the five were to be experienced
in banking and finance butcould not be officers or
directors of a bank or hold any bank stock. However, President Wilson did agree to the establishment of a Federal Reserve Advisory Council consisting of one banker appointed by each Reserve
Bank to meet at least quarterly with the Board to
discuss business conditions in their respective
At the time, only one Board member was designated "Governor" and one "Vice-Governor" (the
others, "members"). The Governor served as "active executive officer" notwithstanding the designation of Treasury Secretary as "Chairman." Initially, the Act did not fix the term of either the
Governor or Vice-Governor as such, and until
1935, when the Board was renamed the "Board of
Governors" and its powers and functions considerably expanded (at the expense of the Reserve
Banks), the President generally appointed a member "Governor" for a year at a time, with frequent
annual extensions.
The Act also empowered the President to remove
board members "for cause." However, to help
ensure thatthe Board and the new System's "banking processes" wou Id, in the words of Congressman Glass, "be as far removed from all sinister
influences as one pole is from another," the Act
also provided for long and staggered terms for the
five presidentially appointed members (ten years,
after an initial phase-in; their terms were changed
to 12 years in 1933 and then to 14 years in 1935),
as well as exemption of the System from the Congressional appropriations process. The rationale
behind a central bank enjoying a substantial degree of "independence" reflects a tacit recognition, underscored by historical experience, that it
is not desirable to place direct control over the
power to create money in the hands of those (the
Congress and the Treasury) who develop spending
programs and who pay the government's bills.

The principal duties of the Federal Reserve Board
(which initially did not include the power to setor

to vary reserve requirements inasmuch as these
were set by the Act itself) were to "examine the
accounts and affairs of each Federal Reserve
Bank," to define the character or paper eligible for
short-term (generally 90-day) discount (but not
including notes drawn for carrying or trading in
stocks and bonds other than U.5. government
securitiesL to IIreview and determine" discount
rates set by the Banks (the word "determine" was
highly ambiguous and shortly led to intense intramural disputes), to appoint the three Class C Reserve Bank directors, to suspend or to remove any
Reserve Bank officer or director for cause, to "set
the rules" under which the Banks would conduct
"open market operations," and to levy annual
assessments on the Reserve Banks to cover the
Board's expenses.
Reserve Bank officials simply did not then conceive
of administering the discount window in such a
way as to initiate credit and monetary expansion
or contraction for the ultimate purpose of deliberately influencing the movement of aggregate income, output, prices and employment. These
goals were expected to be achieved by adheringto
the rules of the gold standard then in place. (That
is, ifthecountry lost gold, perhaps as a resu It of an
adverse trade balance, credit wou Id be restricted
and interest rates raised to dampen economic activity and domestic prices, thereby making American exports more competitive. This, in turn,

would lead to gold inflows, reduced interest rates,
and so on.)

The same was true of '!open market operations,"
including the purchase and sale by Reserve Banks
of notes, bills, bankers' acceptances and drafts
arising from commercial transactions plus government obligations. Initially, these operations were
undertaken separately by individual Reserve
Banks simply to provide themselves with a source
of earnings from which to finance their expenses.
They were not envisioned (or initially even recognized) as a powerful tool of monetary policy-a
discovery not made until the early years of the
"Roaring Twenties."

The Federal Reserve Act was not greeted with
universal enthusiasm. Its passage had been marked
by partisan opposition (from Republicans) and 28

abstentions or absences in the final Senate vote. At
its convention in October, 1913, the American
Bankers Association passed a series of resolutions
denouncing the Act as socialistic, unAmerican,
and (because of its provisions for requiring that
reserves be held at the Reserve Banks) "confiscatory and unconstitutional."
New York investment banker Paul Warburg found
some provisions "deeply alarming and distressing," and claimed they prompted the "determined
opposition on the part of businessmen and bankers." These included Presidential appointment of
members of the Federal Reserve Board (which he
thought wou Id make the Board "hopelessly pol itical"), "excessivedecentraJization" that wou ld re-

su It from twelve Reserve Banks, and the provision
to make Federal Reserve notes obi igations of the
U.S. government as well as of the Reserve Banksa "radical and revolutionary" step, according to
former Senator Nelson Aldrich (R-RIJ, author of a
rival "central bank" plan that would have centralized monetary control in private hands.
To many, the structure of the Federal Reserve System still seems unnecessarily complex and bewildering. But it is precisely its blend of regional and
national interests that makes it representative of
the various elements in American society. Its decentralized structure, under the "capstone" of the
Board of Governors, also protects the Federal Reserve from the sometimes fierce short-term partisan political pressures to which both Congress and
the Executive Branch are subject. This is exactly
why Congress has endeavored to give the System a
substantial degree of independence and insulation from political pressures in its day-to-day conduct of monetary policy. This independence takes
place within government as the Federal Reserve is
still accountable to Congress and must periodically
report its plans and objectives for the monetary
aggregates for a year ahead and how these relate
to the short-term economic goals and projections
of the President and Congress.
The Fed's structure, in short, reflects another practical appl ication of the U.S. phi losophy offederalism, one with its own built-in system of checks and

Verle B.lohnston

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author ...• Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco

94120. Phone (415) 974·2246.









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(Dollar amounts in millions)

Selected Assets and Liabilities
large Commercial Banks
Loans, Leases and Investments 1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
U.S. Treasury and Agency Securities2
Other Secu rities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances4
Total Non-Transaction Balances 6
Money Market Deposit
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS

Weekly Averages
of Daily Fi~ures
Reserve Position, All Reporting Banks
Excess Reserves (+ )/Deficiency (-)
Net free reserves (+ )/Net borrowed( -)
















Period ended


Change from 12/28/83





Period ended

Includes loss reserves, unearned income, excludes interbank loans
Excludes trading account securities
3 Excludes U.S. government and depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers
s Includes borrowing via FRB, TI&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately