Full text of Statements and Speeches of John J. Balles : The Federal Reserve: The Role of Reserve Banks : Ohio State University, Journal of Money, Credit and Banking Lecture, Columbus, Ohio

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R E ADING COPY

THE FE D E R A L RESERVE:

THE ROL E OF

R E S E R V E BANKS

R E M A R K S OF
JOH N J. BALLES, P R E S I D E N T
FE D E R A L R E S E R V E BANK OF SAN F R A N C I S C O

J O U R N A L OF MONEY, C R E D I T
AN D B ANK ING L E C T U R E
THE OHIO ST ATE U N I V E R S I T Y

COLUM BUS , OHIO
M A Y 10, 1983

NOT EDITED FOR P U B L I C A T I O N
OR D I S T R I B U T I O N

T HE FE D E R A L RESERVE :

THE RO L E OF R E S E R V E BANKS

INTRODUCTION
IT W A S A SIGNA L HO N O R TO BE INVIT ED BY P R O F E S S O R D E W A L D TO
G I V E TH IS J O U R N A L OF MONEY, C R E D I T AN D BANKI NG LECTURE.
E S P E C I A L L Y H O N O R E D TO BE THE FIRST PH.D.
A P P E A R HERE.

I FELT

FRO M OH IO ST ATE TO

IN A M E A N I N G F U L WAY, MY V I S I T TO OH I O ST A T E T O D A Y

R E P R E S E N T S A R E T U R N TO MY R O O T S AS A P R O F E S S I O N A L E C O N O M I S T AND
C E N T R A L BANKER.
I WAN T TO TH A N K BILL DEWALD, N OT ONL Y FOR THA T FINE
I N T R ODUCTION,

BUT A L S O FOR H A V I N G BEE N A V I S I T I N G S C H O L A R A T T H E

FE D E R A L R E S E R V E BANK OF SAN F R A N C I S C O IN THE SUMMER AND FALL OF
1981.

D U R I N G T H A T P E R I O D BILL TOO K ON WHA T I C O N S I D E R O N E OF THE

MOST IM P O R T A N T AN D M O S T C H A L L E N G I N G ISS UES IN C U R R E N T POLI C Y
D E B A T E - - T H E I N T E R A C T I O N B E T W E E N F EDERAL D E F I C I T S AND M O N E T A R Y
PO L I C Y A ND ITS IMPACT ON THE ECONOMY.

HIS A N A L Y S I S OF THAT

ISSUE, S U B S E Q U E N T L Y P U B L I S H E D IN T HE W I N T E R 198 2 ISSUE OF O U R
Q U A R T E R L Y E C O N O M I C R E V I E W , WAS,

IN MY OPINIO N, O N E OF THE M O S T

C A R E F U L PIE C E S OF R E S E A R C H ON THA T SU B J E C T T H A T H A S A P PEARED.
W H I L E I AM ON THAT SUBJECT, A N O T H E R V I S I T I N G SC H O L A R F R O M
T HIS G R E A T U N I V E R S I T Y W A S ED KAN E IN 197 5 (JUNE TO S E P T E M B E R
1975).

ED W R O T E A C R I T I Q U E D E S C R I B I N G THE P R O B L E M S OF THE

FEDERA L R E S E R V E IN M A I N T A I N I N G I N TEREST R A T E C E I L I N G S ON BANK
DEP OSIT S, WHICH,

IN MY OPIN ION, HE L P E D SET THE I N T E L L E C T U A L

C L I M A T E FOR T HE G R A D U A L R E D U C T I O N IN IN T E R E S T R A T E C E I L I N G S U N D E R
L E G I S L A T I O N EN A C T E D IN 1980.
WITH REG A R D TO MY T O P I C TODAY,

http://fraser.stlouisfed.org/
PERSUADED
Federal Reserve Bank of St. Louis

IT W A S BILL D E W A L D WH O

M E T H A T S O M E O B S E R V A T I O N S O N T H E R O L E OF R E S E R V E BANKS

W I T H I N THE F E D E R A L R E S E R V E W O U L D BE AN I N T E R E S T I N G SU B J E C T FOR
THIS LECTURE,
SUBJECT.

SI NCE R E L A T I V E L Y L I T T L E HAS BEEN P U B L I S H E D ON THE

T HE C E N T R A L BANK OF T HE U N I T E D ST A T E S H AS A U N I Q U E L Y

F E D E R A L I Z E D STRUCTU RE.

A T THE TOP THE R E IS THE PRE S I D E N T I A L L Y -

A P P O I N T E D BOARD OF GOVER N O R S , W I T H SEV EN MEMBERS .

IN ADDIT ION ,

T H E R E ARE TW E L V E R E G I O N A L R E S E R V E BANKS W I T H A TOT AL OF 48
O P E R A T I N G C E N T E R S OR BRANCHES.

T H E S E R E G I O N A L BANKS A R E Q U A S I -

PUBLIC E N T I T I E S IN THEIR S T R U C T U R E AND OPER ATI ON.

THEY PLAY AN

I M P O R T A N T PA RT IN F O R M U L A T I N G A ND E X E C U T I N G S Y S T E M POLICY,
E S P E C I A L L Y M O N E T A R Y POLICY.

AT THE SAME TIME, TH E Y HA V E THE

R E S P O N S I B I L I T Y FOR C O N D U C T I N G THE S Y S T E M ' S O P E R A T I O N A L
A C T I V I T I E S , SUC H AS C H E C K CLE ARIN G, AND AC T I N G AS THE U.S.
G O V E R N M E N T ' S FIS C A L AGENT.

EACH BANK IS AN I N C O R P O R A T E D

I N S T I T U T I O N W I T H ITS OWN BOARD OF DIR ECT ORS, C O N S I S T I N G OF N I N E
MEMBERS.

T H R E E OF T HE D I R E C T O R S A RE E L E C T E D BY M E M B E R BAN K S TO

R E P R E S E N T BANKING.

TH E O T H E R SIX D I R E C T O R S R E P R E S E N T THE PUBLIC,

WI T H D UE BUT N O T E X C L U S I V E R E G A R D TO THE I N T E R E S T S OF
A G R I C U L T U R E , COMMERCE,

INDUSTRY, SERVICES,

LABO R AND CONSUME RS.

TH R E E OF SUCH D I R E C T O R S AR E E L E C T E D BY M E M B E R BANKS, A N D

THE

O T H E R TH R E E AR E A P P O I N T E D BY THE BOAR D OF G O V E R N O R S IN
W A S H I N G T O N , D.C.

FIN ALL Y, THE BOARD OF G O V E R N O R S A P P O I N T S ,

FROM

AM ONG THE D I R E C T O R S A P P O I N T E D BY IT, THE C H A I R M A N AND D E P U T Y
C H A I R M A N OF A R E S E R V E BA N K ' S BOARD.

THE R E S E R V E BANKS H A V E

R E L A T I V E I N D E P E N D E N C E OF F U N C T I O N TH AT IS NOT D U P L I C A T E D IN ANY
O T H E R CE N T R A L BA N K I N G SYSTEM. THE R E S E R V E BA N K S O P E R A T E U N D E R THE
I M M E D I A T E S U P E R V I S I O N OF THEI R BOARDS OF D I R E CTORS,



S U B J E C T TO

TH E U L T I M A T E A U T H O R I T Y OF THE BOARD OF GO VERNORS.
I B E L I E V E TH AT THIS FEDERAL IZE D,

SE MI-P U B L I C ,

SEMI-PRIVATE

S T R U C T U R E SER VES T HE N A T I O N W E L L IN A LL OF T HE A R E A S IN WH I C H A
C E N T R A L BANK HAS A R E L E V A N T ROLE:

M O N E T A R Y POLICY, BANK

R E G U L A T O R Y AND S U P E R V I S O R Y A U T H O R I T Y A ND IN T HE O P E R A T I O N OF T H E
N A T I O N ' S P A YMENTS M E C H A N I S M .

IN MY P R E S E N T A T I O N TODAY,

LI KE TO E L A B O R A T E ON TH I S STRU CTURE,

I WOULD

L OOKING AT T H E R O L E S OF THE

RE G I O N A L BANKS IN THE F O R M U L A T I O N AND E X E C U T I O N OF POLICY IN EACH
OF THE TH R E E AREAS.

I A L S O W O U L D LI K E TO P R E S E N T MY VI EWS ON TH E

IM P O R T A N C E OF M A I N T A I N I N G AN I N D E P E N D E N T F E D E R A L R E S E R V E W I T H I N
TH E S T R U C T U R E OF U.S. G O V E R N M E N T , AS W E L L AS M E A N I N G F U L R E S E R V E
BANK P A R T I C I P A T I O N IN P O L I C Y M A K I N G W I T H I N THE F E D E R A L RESERVE.
I.

TH E R O L E OF R E S E R V E BANK S IN M O N E T A R Y P O LICY

THE R E S E R V E BANKS H A V E I M P O R T A N T R O L E S IN TWO M A J O R E L E M E N T S
OF M O N E T A R Y P O L I C Y - - D E T E R M I N I N G T HE E S T A B L I S H M E N T AN D A C H I E V E M E N T
OF TH E S Y S T E M ' S O B J E C T I V E S AN D P E R F O R M A N C E FOR T H E R E S E R V E A N D
M O N E T A R Y A G G R E G A T E S , AN D S ETTING T HE D I S C O U N T RATE.

AS AL L OF

YOU KNOW, THE F I R S T F U N C T I O N IS P E R F O R M E D BY T H E S Y S T E M ' S
P R I N C I P A L M O N E T A R Y P O L I C Y M A K I N G B O D Y - - T H E F E D E R A L OP E N M A R K E T
C O M M I T T E E (FOMC).

AL O N G W I T H THE SE VEN M E M B E R S OF TH E BO ARD OF

GOVERNORS, FIV E OF THE T W E L V E R E S E R V E BANK P R E S I D E N T S SIT AS
VOTI NG M E M B E R S ON TH E FOMC AT AN Y G I V E N TIME.

TH E P R E S I D E N T OF

THE NEW YORK BANK IS A P E R M A N E N T VOTING MEMBER, A ND THE O THER
ELEVE N P R E S I D E N T S A L T E R N A T E AS VOTI NG MEM BER S.

(THE P R E S I D E N T S

OF C HICAGO AN D C L E V E L A N D A L T E R N A T E EVERY OT H E R YEAR, A N D THE
R E M A I N I N G P R E S I D E N T S A L T E R N A T E E V E R Y THIRD Y E A R ) .

IN T H E I R OFF-

YEARS, P R E S I D E N T S P A R T I C I P A T E IN THE PO L I C Y D I S C U S S I O N S A ND GIVE



TH E I R R E C O M M E N D A T I O N S , A L T H O U G H T H E Y DO N OT H A V E A VOTE.
D I S C O U N T P O L I C Y (SETTI NG THE R A T E AND A D M I N I S T E R I N G
B O R R O W I N G BY D E P O S I T O R Y I N S T I T U T I O N S F R O M T HE R E S E R V E BANKS)
TH E S ECOND M A J O R EL E M E N T OF M O N E T A R Y POLICY.

IS

THE BOARD S OF

D I R E C T O R S OF T HE I N D I V I D U A L R E S E R V E BA NKS I N I T I A T E C H A N G E S IN THE
D I S C O U N T RATE,
IN W A S H I N G T O N .

S U B J E C T TO THE A P P R O V A L OF THE BOAR D OF G O V E R N O R S
T H E S E D E C I S I O N S A RE M A D E BY R E S E R V E BANK

D I R E C T O R S AFT E R R E C E I V I N G E X T E N S I V E B R I EFING BY THE BANKS'
R E S E A R C H STA FFS A ND R E C O M M E N D A T I O N S BY THE R E S E R V E BANK
PR ESIDENTS, AND A RE BASED ON C O N S I D E R A T I O N S OF M O N E T A R Y P O L I C Y
AND THE S Y S T E M ' S F U N C T I O N AS T HE L E N D E R OF LAS T RESO RT .

DISCOUNT

W I N D O W C R E D I T IS A D M I N I S T E R E D BY THE R E S E R V E BA NK S IN A C C O R D A N C E
WITH E S T A B L I S H E D G U I D E L I N E S AS TO F R E Q U E N C Y A ND A M O U N T OF
BO RROWING BY E L I G I B L E INSTIT UTI ONS .
D I S C O U N T R A T E PO L I C Y IS AN I M P O R T A N T PAR T OF M O N E T A R Y
POLICY.

THE R E L A T I O N S H I P OF THE D I S C O U N T R A T E TO O P E N - M A R K E T

I N T E R E S T R A T E S A F F E C T S T HE A M O U N T OF R E S E R V E S D E P O S I T O R Y
I N S T I T U T I O N S B O R R O W AND,

IN THA T WAY, THE TO TAL R E S E R V E S

A V A I L A B L E TO S U P P O R T THE M O N E T A R Y A ND C R E D I T AGG R E G A T E S .
A L T H O U G H B O R R O W E D R E S E R V E S A RE A SMALL PART OF THE LE VEL OF T OTAL
RE SERVES, O F T E N T HE C H A N G E IN B O R R O W I N G S C O N T R I B U T E S
S I G N I F I C A N T L Y TO THE C H A N G E IN TOT A L R E S E R V E S AND H E N C E TO
C H A N G E S IN T HE AGGREG A T E S .

C H A N G E S IN T HE D I S C O U N T R A T E

S O M E T I M E S ALSO HAV E AN I M P O R T A N T " A N N O U N C E M E N T EFFECT" W H E N
M A R K E T S I N T E R P R E T THE C H A N G E AS S I G N A L L I N G A S I G N I F I C A N T P O LICY
SH IFT AN D I N C O R P O R A T E THE S E E X P E C T A T I O N S INTO M A R K E T R A T E S OF
INTEREST.



THE R E S E R V E BANKS P E R F O R M TWO U N I Q U E F U N C T I O N S W I T H I N THE
C O N T E X T OF M O N E T A R Y POLICY.

FIRST, EACH R E S E R V E BANK P R E S I D E N T

D R A W S ON AN I N D E P E N D E N T A N A L Y S I S TO FOR M HIS OWN V I E W ON
A P P R O P R I A T E M O N E T A R Y POLICY.

EAC H P R E S I D E N T H AS A R E S E A R C H S T A F F

W I T H W H I C H TO A P P R A I S E N A T I O N A L POLICY A N D R E G I O N A L ECO N O M I C
D E V E L O P M E N T S F R O M A U N I Q U E PE RSP ECT IVE.

SECOND, R E S E R V E BAN K

D I R E C T O R S C O M P R I S E A R E G I O N A L I N F O R M A T I O N NE T W O R K ON THE L A T E S T
D E V E L O P M E N T S A N D O U T L O O K IN KEY I N D U S T R I E S A N D D I F F E R E N T REG ION S.
THIS NETWO RK P E R F O R M S TWO V I T A L FUNCTIONS.

FIRST,

IT P R O V I D E S

TH E S Y S T E M WIT H T I M E L Y I N F O R M A T I O N A B O U T THE E C O N O M Y IN A D V A N C E
OF P U B LISHE D STATIS TIC S.

THUS D I R E C T O R S OF T E N HE L P US TO D E T E C T

T R E N D S BE F O R E TH E Y SHO W UP IN TH E F O R M A L DATA.

SECOND,

IT K EEPS

US A P P R I S E D OF THE IMPAC T OF POLICY ON D I F F E R E N T SE C T O R S AND
REG ION S,

I N F O R M A T I O N T H A T IS O F T E N D I F F I C U L T TO GE T F R O M

A G G R E G A T E NUMBERS.
INDEPENDENT ANALYSIS
I SHALL D I S C U S S THE R E S E R V E BANKS'

I N V O L V E M E N T IN M O N E T A R Y

P OLI CY IN TE R M S OF T H E S E TWO I M P O R T A N T ASPEC TS:
A N A L Y S I S AN D I N F O R M A T I O N NETWORKS.

INDEPENDENT

TH E FIRS T A S P E C T IS THAT

R E S E R V E BANK P R E S I D E N T S D E V E L O P I N D E P E N D E N T L Y A V I E W OF PO L I C Y ON
THE BASIS OF TH E I R OWN E X P E R I E N C E S A N D KNOW LEDGE, THE INPUT THEY
R E C E I V E F R O M TH E I R D I R E C T O R S A ND TH E ADVICE OF T H E I R R E S E A R C H
STAFFS.
ANY O R G A N I Z A T I O N , W H E T H E R IT IS THE BOARD OF G O V E R N O R S OR A
R E S E R V E BANK, TE N D S TO D E V E L O P BLIND S P O T S - - T O E X C L U D E
I N A D V E R T E N T L Y F R O M S E R I O U S C O N S I D E R A T I O N C E R T A I N TYPES OF
S O L U T I O N S TO T HE P R O B L E M S T H A T ARISE.



TH E D E C E N T R A L I Z E D

O R G A N I Z A T I O N OF TH E F E DERAL R E S E R V E SY S T E M IS I DEAL LY D E S I G N E D TO
A V O I D THIS PROBLEM.

EAC H P A R T I C I P A N T R E P R E S E N T E D ON THE FOMC

C O M E S TO TH E M E E T I N G W I T H ITS OW N I N D E P E N D E N T L Y - A R R I V E D - A T V I E W
OF THE P R O B L E M S AND ISSUES FACING THE COMMITTEE, A ND THE
I N T E R A C T I O N OF T H E S E A P P R O A C H E S E N S U R E S TH AT A L L THE P O S S I B L E
S O L U T I O N S A R E CO NS IDERED.
T H E R E ARE M A N Y E X A M P L E S OF IM P O R T A N T C O N T R I B U T I O N S M A D E BY
R E S E R V E BANK S TO TH E M O N E T A R Y D E B A T E S AT TH E FOMC A ND THE
PO L I C I E S A C T U A L L Y ADOPTE D.

THE E X A M P L E S I WI L L CI T E AR E BY NO

M E A N S IN TENDED TO BE C O M P R E H E N S I V E , BUT ONL Y TO I L L U S T R A T E H O W
V I E W S D E V E L O P E D AT R E S E R V E BANKS HA V E C O N T R I B U T E D TO THE
P O L I C Y M A K I N G PROCESS.

A W E L L - K N O W N E X A M P L E IS T HE I M P O R T A N T R O L E

OF THE FE D E R A L R E S E R V E BANK OF ST. LOUIS IN THE LAT E 1 9 6 0 ’
S AND
EA RLY 1 9 7 0 'S IN E V E N T U A L L Y C O N V I N C I N G T HE S Y S T E M AS A W H O L E T H A T
MOR E E M P H A S I S SHOULD BE PL A C E D ON THE M O N E T A R Y A G G R E G A T E S AS
I N T E R M E D I A T E T A R G E T S OF POLICY.

A N O T H E R E X A M P L E WAS THE R O L E

P LAY ED BY T HE F E D E R A L R E S E R V E BANK OF M I N N E A P O L I S IN THE LATE
1970'S IN H I G H L I G H T I N G THE I M P O R T A N C E OF T HE P U B L I C ' S
E X P E C T A T I O N S A B O U T F U T U R E E C O N O M I C EVENTS ON THE A P P R O P R I A T E
C H O I C E OF P O L I C I E S BY THE F E D E R A L RESERVE.
A FINA L E X A M P L E OF I N D E P E N D E N T INPUT TO M O N E T A R Y P O L I C Y
COM E S O UT OF A M O N E Y M A R K E T M O D E L D E V E L O P E D BY M Y STAFF.

THE

S T R U C T U R E AND P E R F O R M A N C E OF THE SAN F R A N C I S C O M O D E L W E R E
R E V I E W E D L A S T Y EA R A T A C O N F E R E N C E S P O N S O R E D BY THE A M E R I C A N
E N T E R P R I S E INSTITU TE, A ND THE P R O C E E D I N G S OF THAT C O N F E R E N C E W E R E
P U B L I S H E D BY T HE J M C B .

T HE M O D E L R E P R E S E N T S A D I F F E R E N T A P P R O A C H

TO A N A L Y Z I N G A ND P R E D I C T I N G G R O W T H IN Ml T H A T F O C U S E S ON THE W A Y S



IN W H I C H C R E D I T - M A R K E T A C T I V I T I E S OF BA N KS A N D T HE PU BLIC
D O M I N A T E IN THE SHORT R U N IN D E T E R M I N I N G THE Q U A N T I T Y OF MONEY.
FOR EXAMPLE,

IT SHOWS H O W C H A N G E S IN BANK C R E D I T CA N I N F L U E N C E

TH E G R O W T H IN Ml.

IN THIS RE SP ECT,

IT DI F F E R S FR O M C O N V E N T I O N A L

M O DELS, W H I C H FOCUS P R I M A R I L Y ON THE D E M A N D FOR M O N E Y TO P R E D I C T
MO N E Y GROWTH.
THI S WOR K S U G G E S T S TH A T M A N Y S H O R T - R U N M O V E M E N T S IN Ml A R E
C A U S E D BY M O N E Y - SUPPLY IN STABIL ITY, AND N O T BY I N S T A B I L I T Y IN T H E
D E M A N D FOR MONEY.

T HE PO L I C Y I M P L I C A T I O N S OF THIS M O N E Y - S U P P L Y

I N T E R P R E T A T I O N A R E THA T S H O R T - R U N D E V I A T I O N S OF Ml FRO M T A R G E T
SHOULD BE A C C O M M O D A T E D LESS O F T E N THAN IS C U R R E N T L Y THE PRACTICE.
REGIONAL INFORMATION
THE SEC OND M A J O R A S P E C T OF THE R E S E R V E BANKS'

I N V O L V E M E N T IN

M O N E T A R Y P O L I C Y IS T HE D I V E R S E I N F O R M A T I O N N E T W O R K THA T D E V E L O P S
FRO M THE S T R U C T U R E OF THE SYSTEM.

THE R E S E R V E BANKS P R O V I D E A

C H A N N E L T H R O U G H W H I C H THE P R O B L E M S AN D C O N C E R N S OF TH E V A R I O U S
R E G I O N S OF THE C O U N T R Y CAN BE R E F L E C T E D IN THE P O L I C Y M A K I N G
PROCESS.

THE VO T I N G P A R T I C I P A T I O N OF TH E P R E S I D E N T S ON T H E FOMC

AND THE P A R T I C I P A T I O N OF THE R E S E R V E BANK D I R E C T O R S IN SET TING
TH E D I S C O U N T R A T E R E F L E C T S THE O R I G I N A L - - A N D I B E L I E V E S TILL
V A L I D - - P R E M I S E OF THE F E D E R A L R E S E R V E ACT, THA T A D E Q U A T E
G E O G R A P H I C A L R E P R E S E N T A T I O N IN M O N E T A R Y PO LICY AT T H E KEY
D E C I S I O N - M A K I N G L E V E L S IS OF C R U C I A L IMPORTANCE.
IT O B V I O U S L Y M AY A P P E A R S E L F - S E R V I N G FOR ME AS A P R E S I D E N T
TO DEF EN D THE P R E S E N T S Y S T E M WHICH G I V E S A V O T E ON THE FOMC TO
FIVE PRESID ENT S, A T A N Y O N E TIME.

THUS,

I W O U L D L IK E TO Q U O T E

FROM A LETT ER ON T HI S SU B J E C T FR O M PAUL VOLCKE R, C H A I R M A N OF THE



BOARD OF G O V E R N O R S , TO T HE C H A I R M A N OF THE S U B C O M M I T T E E O N
D O M E S T I C M O N E T A R Y P O L I C Y OF THE HOU S E BANK IN G COMMI TTE E,
S E P T E M B E R 8, 1980.

AT THA T TIME, A BILL WAS BEING C O N S I D E R E D TO

R E M O V E THE R E S E R V E BANK P R E S I D E N T S FR O M A VOTING ROL E IN THE
FOMC.

IN E X P R E S S I N G HIS STRONG O P P O S I T I O N TO THE BILL, C H A I R M A N

V O L C K E R STATED:

" F R O M THE B E G I N N I N G THE FE D E R A L R E S E R V E S Y S T E M HAS
BEE N BAS E D ON A C O M B I N A T I O N OF C E N T R A L A N D R E G I O N A L
ELEMENTS.
IT W A S CONG RES S' IN T E N T I O N THA T T W E L V E
F E DERAL R E S E R V E BANKS SHOULD BE E S T A B L I S H E D A N D GI V E N A
S I G N I F I C A N T R O L E IN THE O P E R A T I O N OF THE SY S T E M IN
O R D E R TO A S S U R E A PROPE R C O N S I D E R A T I O N OF V I E W P O I N T S
A N D NE E D S FROM A LL SE C T I O N S OF THE COUNTRY.
THE
P R E M I S E W A S T H A T A LL W I S D O M DO E S N OT R E S I D E IN
W A S H I N G T O N AND THAT SOME F U RTHER I N S U L A T I O N F R O M S H O R T ­
T E R M AN D P A R T I S A N P O L I T I C A N P R E S S U R E W O U L D C O M E F R O M
GIVING AN I M P O R T A N T R O L E TO THE R E S E R V E BANKS.
" ____THE R E S E R V E BANK P R E S I D E N T S A N D T H E I R
R E S E A R C H STAFFS BRING TO THE FOMC K N O W L E D G E AND
I N F O R M E D O P I N I O N A B O U T R E G I O N A L I N T E R E S T S A ND NEED S.
THE Y A R E C L O S E R TO THE N A T I O N ' S C O M M ERCE, IN D U S T R Y AN D
A G R I C U L T U R E THA N A NY PUREL Y W A S H I N G T O N - B A S E D
O R G A N I Z A T I O N CAN B E ____"
A L T H O U G H M O N E T A R Y PO LICY MU ST BE FORMUL A T E D IN R E F E R E N C E TO
ITS N A T I O N A L IMPACT, INCLUDING ITS INFLU E N C E U P O N INCOME, OUTPUT,
AND EMPLOY ME NT , THI S C O N S I D E R A T I O N IN NO W A Y O B V I A T E S THE
IMPORTANCE OF S I G N I F I C A N T D E V E L OPMENTS, OR P R O S P E C T I V E
D EVELOPMENTS,

IN P A R T I C U L A R R E G I O N S OR ECON OM IC SECTORS.

BY

D EF IN IT IO N, N A T I O N A L A G G R E G A T E S R E F L E C T THE C O M P O S I T E OF
D I F F E R E N T I A L D E V E L O P M E N T S IN PARTIC U L A R R E G I O N S AND SECTORS.
EVEN IN AN ERA OF P R O G R E S S I V E H O M O G E N I Z A T I O N , S I G N I F I C A N T
D I F F E R E N T I A L S STILL EXI ST IN THE S T R U C T U R E AND O R I E N T A T I O N OF
R E G I O N A L E C O N O M I E S A N D F I N A N C I A L IN STITUTIONS.




IN SUCH

SITUATIONS, T H E R E IS NO S U B S T I T U T E FOR H A V I N G F I R S T - H A N D
K N O W L E D G E AND E X P E R I E N C E AB O U T R E G I O N A L NEE D S AND D E V E L O PMENTS.
D I R E C T O R S OF R E S E R V E BANKS PLAY A C R I T I C A L R O L E IN THIS
PROCESS.

THE Y PR O V I D E U P - T O - D A T E ,

F I R S T - H A N D I N F O R M A T I O N ON KEY

D E V E L O P M E N T S IN V A R I O U S G E O G R A P H I C R E G I O N S A N D V A R I O U S S E C T O R S OF
THE ECONOMY.

IN THIS WAY, TH EY C O M P L E M E N T THE INTE RNAL R E S E A R C H

E F F O R T S OF THE R E S E R V E BA N K S A ND THE BOAR D OF GOVERN ORS.
DI RECTORS'

INPUTS INTO THE I N F O R M A T I O N - G A T H E R I N G PR O C E S S H E L P THE

FED A N T I C I P A T E C H A N G I N G T R E N D S IN THE EC O N O M Y A ND PR O V I D E C U R R E N T
INSIGHT INTO C O N S U M E R A ND B U S I N E S S P S Y C H O L O G Y T H A T IS D I F F I C U L T
TO GET F R O M THE A N A L Y S I S OF S T A T I S T I C S ALONE.

BOTH F O R M E R

C H A I R M A N A R T H U R BURNS, A N D P/VUL VOL CKE R, OUR C U R R E N T C HAIRMAN,
HA V E NOTED THA T DIRECT O R S '

O B S E R V A T I O N S ON T HE E C O N O M Y H A V E

PA R T I C U L A R VAL U E P R E C I S E L Y BE C A U S E THEY A RE D I R E C T AND TIMELY.
II.

I N D E P E N D E N C E OF THE FE D E R A L R E S E R V E

IT IS D I F F I C U L T TO D I S C U S S T H E I M P O R T A N C E OF I N D E P E N D E N C E OF
T H O U G H T AND A C T I O N ON THE PAR T OF THE INDIVI D U A L R E S E R V E BANKS
W I T H O U T A D D R E S S I N G T HE B R OADER ISSUE OF T HE I N D E P E N D E N C E OF TH E
FE D E R A L R E S E R V E S Y S T E M W I T H I N GOVERNMEN T.
THE B ANKING A C T OF 1935 C O N S O L I D A T E D R E S P O N S I B I L I T Y FOR
M O N E T A R Y POLICY, BY R E O R G A N I Z I N G THE FE D E R A L OP E N M A R K E T
C O M M I T T E E TO IN C L U D E THE SEVEN M E M B E R S OF TH E BOARD OF GOV E R N O R S ,
AND, /VT AN Y O N E TIME,

FIV E OF THE R E S E R V E BANK PR ESIDENTS,

T H E R E B Y C R E A T I N G A M O R E EFFICIENT,

BUT C E N T R A L I Z E D , FO C U S OF

POLIC Y MAKING.
TH A T AC T ALS O R E M O V E D THE T R E A S U R Y S E C R E T A R Y A ND THE
C O M P T R O L L E R OF C U R R E N C Y F R O M EX O F F I C I O M E M B E R S H I P ON T HE BOARD,



-

10

-

IN R E S P O N S E TO G R O W I N G C O N G R E S S I O N A L C O N C E R N OVE R T HE E X C E S S I V E
IN F L U E N C E W H I C H TH EY W E R E BE L I E V E D TO HA VE EX E R T E D AT V A R I O U S
T I M E S ON BEHALF OF TH E E X E C U T I V E BRANCH.

AS S E N A T O R CART E R

GLASS, ON E OF THE A U T H O R S OF THE FE D E R A L R E S E R V E AC T AND H I M S E L F
A F O R M E R S E C R E T A R Y OF T HE TR EASURY, N O T E D IN T HE C O N G R E S S I O N A L
RECORD- ^ :
" T H E T R E A S U R Y S E C R E T A R Y E X E R T E D E N O R M O U S I N F L U E N C E ON THE BOARD,
O F T E N T I M E S T R E A T I N G IT AS A 'BUREAU OF T HE T R E A S U R Y INSTE AD OF AS
A BOAR D I N D E P E N D E N T OF THE G O V E R N M E N T ' , A ND TH A T ON OCC ASI ON,
'THE FE D E R A L R E S E R V E BA N K I N G S Y S T E M H A S BEEN M A D E A D O O R M A T OF
THE UNITED ST ATES T R E A S U R Y ' . "
THE DEBATE OV ER W H A T C O N S T I T U T E S THE A P P R O P R I A T E D E G R E E OF
FED I N D E P E N D E N C E W I T H I N G O V E R N M E N T C O N T I N U E S INTO T H E PRESENT.
R E C E N T L Y THE A D M I N I S T R A T I O N HAS C O N S I D E R E D S E V E R A L O P T I O N S THAT
W O U L D M O D I F Y T H E I N D E P E N D E N C E OF T HE BOARD OF G O VERNORS,
INCLUD ING PLAC ING T H E T R E A S U R Y S E C R E T A R Y BACK ON THE BOARD, OR
M A K I N G THE BOARD PA RT OF T HE TREASURY.

IN A D D ITION, N U M E R O U S

P R O P O S A L S HAVE BEEN I N T R O D U C E D IN CON GR ESS,

INCL UD ING P R O P O S A L S

T H A T W O U L D PL A C E T HE T R E A S U R Y S E C R E T A R Y BACK ON T HE BOARD A N D
SU B J E C T THE SYS T E M TO THE C O N G R E S S I O N A L A P P R O P R I A T I O N S PROCESS.
IN A S S E S S I N G THE N A T U R E AN D R A T I O N A L E OF T H E S Y S T E M ' S
INDE PEN DEN CE,

IT IS I M P O R T A N T TO NOT E THAT W H I L E THE BO ARD OF

G O V E R N O R S IS A P P O I N T E D BY THE P R E S I D E N T WIT H T H E A D V I C E A N D
C O N S E N T OF THE SENATE, THE SYS TEM D E R I V E S
U L T I M A T E L Y IS R E S P O N S I B L E TO, CONG RES S.

1/

ITS POWER FROM, AND
MOREOVER, WHEN CONGRESS

C O N G R E S S I O N A L RECO RD, VOL 76, 1932 (PP 1938,

1935 (PP 11 77 6-77)



2264); VO L 79,

-

11

-

A C C O R D E D T HE S Y S T E M A V E R Y S U B S T A N T I A L -- BUT BY NO M E A N S T O T A L - D E G R E E OF I N D E P E N D E N C E W I T H I N , BUT NOT OF THE G O V E R N M E N T ,
D A Y - T O - D A Y C O N D U C T OF M O N E T A R Y POLICY,
C O N S C I O U S DE CISION.

IN ITS

IT DI D SO IN R E S P O N S E TO A

THIS DE C I S I O N R E F L E C T E D A T A C I T RECO G N I T I O N ,

U N D E R S C O R E D BY A B U N D A N T H I S T O R I C A L EXPE RIENCE, TH A T C O N T R O L OVER
THE POWER TO C R E A T E M O N E Y SH O U L D BE KE P T OUT OF THE HANDS OF
T H O S E C H A R G E D W I T H TH E R E S P O N S I B I L I T Y OF F A S H I O N I N G SPEN D I N G
P R O G R A M S AND PAYI NG TH E N A T I O N ' S BILLS.

IT W AS E X P ECT ED THA T IF

S U F F I C I E N T L Y IN S U L A T E D F R O M T HE SO M E T I M E S F I E R C E P O L I T I C A L
P R E S SURES TO WH I C H TH E C O N G R E S S ITSELF IS SUBJECT, TH O S E C H A R G E D
WIT H M A N A G I N G THE N A T I O N ' S M O N E Y AN D C R E D I T W O U L D F R A M E T H E I R
P O L I C I E S IN R E L A T I O N TO WHA T THEY P E R C E I V E AS THE N A T I O N ' S BE ST
L O N G -TERM INTERESTS.
BY TH E SAME TOKEN,

IN D E L E G A T I N G A U T H O R I T Y OV ER THE DA Y-TO-

DAY C O N D U C T OF M O N E T A R Y POL I C Y TO TH E FED, TH E C O N G R E S S
R E C O G N I Z E D THA T A VE R Y L A R G E D E L I B E R A T I V E BODY SUCH AS ITSEL F
SI M P L Y W AS N O T W E L L E Q U I P P E D TO DEAL WIT H T HE T E C H N I C A L
C O M P L E X I T I E S OF THE N A T I O N ' S M O N E T A R Y A ND C R E D I T NEEDS, A
P R A C T I C A L C O N S I D E R A T I O N WH I C H D E R I V E S ADDED I M P O R T A N C E IN T O D A Y ' S
R A P I D L Y CH A N G I N G E C O N O M I C A ND F I N A N C I A L ENVIRON MEN T.
H A V I N G SAID THIS,

I W O U L D A L S O N O T E THA T IN T H E L A S T

A N A L Y S I S NO C E N T R A L BANK H AS THE A U T H O R I T Y -- NOR SHOULD IT H A V E
TH A T A U T H O R I T Y IN A D E M O C R A T I C SOCIET Y -- TO N U L L I F Y OV E R A N
E X T E N D E D PE RIOD THE P R O G R A M S AN D P O L I C I E S OF TH E N A T I O N ' S EL ECTED
REPRESENTATIVES.

A N D THA T IS TRU E NO M A T T E R H O W S H O R T - S I G H T E D OR

U N W I S E G O V E R N M E N T PO L I C I E S M AY A P P E A R TO C E N T R A L BANKERS.



THUS,

-

12

-

IN M Y VIEW, W H A T " I N D E P E N D E N C E " M E A N S IN P R A C T I C E IS THA T THE
C E N T R A L BANK SHOULD SPEAK OU T F O R C E F U L L Y AND P U B L I C L Y ON ITS
P E R C E P T I O N S OF SOUND E C O N O M I C A ND F I N A N C I A L POLICY, AND T H A T IT
SH OULD ACT D E C I S I V E L Y W I T H I N THE LIM ITS OF ITS A U T H O R I T Y TO
F O L L O W A P P R O P R I A T E P O L I C I E S TO A C H I E V E D E S I R E D RESULTS.
FOREI GN E X P E R I E N C E
THE IMPORT A N C E OF INSU LATING T H O S E R E S P O N S I B L E FOR C R E A T I N G
A C O U N T R Y ' S M O N E Y F R O M T H O S E R E S P O N S I B L E FOR PA Y I N G THE
G O V E R N M E N T ' S BILLS IS S O M E T I M E S D I F F I C U L T TO A P P R E C I A T E LOOKING
AT OUR OW N M O N E T A R Y HISTORY .

HO WEVER,

IF WE C O M P A R E THE

P E R F O R M A N C E OF C E N T R A L BA NKS IN AN I N T E R N A T I O N A L CONTE XT, TH E
R E L A T I O N S H I P IS Q U I T E CLEAR.
THE W I L S O N R E P O R T ON F I N A N C I A L I N S T I T U T I O N S —^ P R E S E N T E D TO
THE B RITISH P A R L I A M E N T IN 1980 A T T E M P T E D TO M E A S U R E T H E D E G R E E OF
CE N T R A L BANK I N D E P E N D E N C E W I T H I N VA R I O U S D E V E L O P E D W E S T E R N
ECONOMIES.

TH E R E P O R T C O N C L U D E D THAT S W I T Z E R L A N D A ND W E S T

G E R M A N Y WER E THE ONLY TWO N A T I O N S SU R V E Y E D THA T COU L D BE
C H A R A C T E R I Z E D AS H A V I N G " L A R G E L Y I N D E P E N D E N T " - ^ C E N T R A L BANKS.
A S S O C I A T E D W I T H C E N T R A L BANK I N D E P E N D E N C E IN S W I T Z E R L A N D AN D
W E S T G E R M A N Y A R E V E R Y I M P R E S S I V E R E C O R D S OF LOW I N F L A T I O N -- M U C H
BE TTER THA N THE OT H E R C O U N T R I E S SURVEYED.

P E R H A P S M O R E STRIKING

2/ R E P O R T OF THE U N I T E D K I N G D O M C O M M I T T E E TO R E V I E W THE
F U N C T I O N I N G OF F I N A N C I A L IN S TITUTIONS, SIR H A R O L D WIL SO N,
CHAIRMAN, H M S O , LONDON, 1980.
3/

REP ORT , VOL.II, A P P E N D I X 2.1, P. 37.




-

13

-

HOWEVER, A R E THE POOR I N F L A T I O N R E C O R D S OF T H O S E C O U N T R I E S W H O S E
C E N T R A L BA NKS ARE,

IN THE W O R D S OF THE W I L S O N REPORT , " S U B J E C T TO

G E N E R A L D I R E C T I O N S OF G O V E R N M E N T 11. TH E LEGAL,

1

I N S T I T U T I O N A L AND O P E R A T I O N A L F A C T O R S A F F E C T I N G A

C E N T R A L BANK'S R E L A T I O N S H I P W I T H ITS N A T I O N A L G O V E R N M E N T V A R Y
F R O M C O U N T R Y TO C O U N T R Y AND THE A B O V E C H A R A C T E R I Z A T I O N IS
A D M I T T E D L Y A R O U G H ONE.

C E N T R A L BA NK I N D E P E N D E N C E A L O N E W I L L N O T

G U A R A N T E E G E N E R A L PRICE ST AB ILIT Y; N A T I O N A L R E S O L V E TO P R O M O T E
N O N I N F L A T I O N A R Y E C O N O M I C P O L I C I E S IS ALS O NECE S SARY.
N E V E R T H E L E S S , TH E E X A M P L E S FRO M AMO N G I N D U S T R I A L C O U N T R I E S DO
S U G G E S T THA T THE G R E A T E R THE D E G R E E OF C E N T R A L BANK I N D E P E N D E N C E
W I T H I N G O V E R N M E N T , TH E G R E A T E R S U C C E S S A C O U N T R Y W I L L H A V E IN
M A I N T A I N I N G PR ICE STABI LITY .
R E P R E S E N T A T I O N OF THE R E S E R V E BANKS ON THE FOMC IS, I
BELIEVE, AN E S S E N T I A L E L E M E N T IN TH IS D E F E N S E OF OUR N A T I O N ' S
CUR RENC Y.

THE P A R T I C I P A T I O N OF THE D I S T R I C T BO A R D S OF D I R E C T O R S

IN D E T E R M I N I N G THE D I S C O U N T RA T E AND TH E V O T I N G P A R T I C I P A T I O N OF
TH E P R E S I D E N T S OF THE R E S E R V E BANKS ON THE F E D E R A L OPE N M A R K E T
C O M M I T T E E R E F L E C T S THE O R I G I N A L P R E M I S E OF THE F E D E R A L R E S E R V E
A CT OF 1913 THA T R E G I O N A L D I S P E R S I O N OF POLICY INPUT W O U L D
P R O M O T E A M O R E E F F E C T I V E AND I N D E P E N D E N T M O N E T A R Y POLICY.

IN M Y

VIEW, THEREF ORE, T HE N A T I O N IS W E L L SERVE D BY A C E N T R A L BAN K TH AT
IS I N D E P E N D E N T W I T H I N G O V E R N M E N T A ND BU ILT U P O N A STRONG R E G I O N A L
BASE.

4/

R e p o r t , Vol.




II, A p p e n d i x 2.1, p. 36.

-

III.

14

-

BANK R E G U L A T O R Y A N D S U P E R V I S O R Y POL ICY

TH E R E G U L A T I O N A N D S U P E R V I S I O N OF BANK S A N D OT H E R D E P O S I T O R Y
I N S T I T U T I O N S O F T E N IS T H O U G H T OF AS D I S T I N C T F RO M M O N E T A R Y
POLICY.

IN MAN Y WAY S TH I S IS TRUE.

BUT AT A F U N D A M E N T A L L EVEL

THE S E TWO ARE A S OF POLICY A R E ALSO I NTERD EPENDENT.

I WO U L D LIKE

F I R S T TO D E S C R I B E THE R O L E OF THE R E S E R V E BA NKS IN R E G U L A T I O N A N D
SUPERV I S I O N , A N D T HE N R E L A T E TH ESE F U N C T I O N S TO M O N E T A R Y POLICY.
R E S E R V E BANK I N V O L V E M E N T
LET ME D E F I N E FIRST W H A T I M E A N BY R E G U L A T O R Y AND
S U P E R V I S O R Y POLICIES.

BY R E G U L A T O R Y POLICY,

SETT I NG OF FO RMAL RULES.

IN CONTRA ST,

I R E F E R TO T H E

BY S U P E R V I S O R Y POLICY,

M E A N THE I N T E R P R E T A T I O N A ND E N F O R C E M E N T OF T H E S E RULES.

I

THESE

D E F I N I T I O N S IMPLY A N E C E S S A R Y I N T E R A C T I O N B E T W E E N R E G U L A T I O N AND
SU PE RVISION,

BUT TH E Y DO N O T IMPLY THAT TH E TWO F U N C T I O N S N E E D BE

C A R R I E D OUT BY A SINGLE G O V E R N M E N T A L A G E N C Y OR BY A P A R T I C U L A R
EN T I T Y W I T H I N AN AGENCY.
W I T H I N THE FE D E R A L R E S E R V E SYSTEM, R E G U L A T O R Y P O L I C Y IS THE
R E S P O N S I B I L I T Y OF THE S E V E N - M E M B E R BOARD OF GOVE RNORS.

UNLIKE

M O N E T A R Y POLICY, TH E R E S E R V E BANK P R E S I D E N T S DO NOT HA V E A D I R E C T
VO T E ON R E G U L A T O R Y MATTERS.

WE DO H A V E AN O P P O R T U N I T Y , HOWEV ER,

TO SH ARE IN THE M A K I N G OF R E G U L A T O R Y PO L I C Y T H R O U G H OUR A B I L I T Y
TO M A K E FORMAL, A N D IN SOME I N S T A N C E S INFORMAL, R E C O M M E N D A T I O N S .
Q U E S T I O N S ON SUCH M A T T E R S FR O M THE BOARD COME D I R E C T L Y TO ME, A N D
I D R A W ON M Y STAFF TO P R O V I D E M E WI T H T H E I R D E T A I L E D A N A L Y S E S OF
P R OPOSED R E G U L A T O R Y CHANGES.




T H R O U G H THIS PROCESS, TH E D I V E R S E

-

15

-

V I E W P O I N T S OF THE R E S E R V E BANK P R E S I D E N T S A N D TH E I R ST A F F S E N T E R
INTO THE F O R M U L A T I O N OF THE F E D E R A L R E S E R V E ' S R E G U L A T O R Y POLICY.
W I T H I N THIS BROAD C O N T E X T OF R E G U L A T O R Y PO L I C Y MAKING, M A N Y
S P E C I F I C R E G U L A T O R Y D E C I S I O N S ARE " D E L E G A T E D " TO THE R E S E R V E
BANKS.

FOR EXAMPLE,

IN THE CASE OF BANK A N D BANK H O L D I N G C O M P A N Y

A P P L I C A T I O N S FOR ME RGERS, A C Q U I S I T I O N S , C O R P O R A T E FORMA TIO NS, A N D
N E W A C T I V I T I E S , R O U T I N E CA S E S AR E E X P E D I T E D BY H A N D L I N G THE
E N T I R E P ROCESS AT THE R E S E R V E BANK LEVEL.

N O N - R O U T I N E C A S E S ARE

F I R S T A N A L Y Z E D AT THE R E S E R V E BANK LE VEL A ND T H E N F O R W A R D E D W I T H
OUR R E C O M M E N D A T I O N S TO THE BOAR D OF G O V E R N O R S FOR R E V I E W A N D
FINAL DECISION.

IN TH I S MANN ER, E F F I C I E N C Y A N D C LOSE

I N S T I T U T I O N A L C O N T A C T S A R E M A I N T A I N E D ON R O U T I N E CASES, W H I L E THE
N E C E S S A R Y A D V A N T A G E S OF U N I F O R M N A T I O N A L PO L I C Y A R E G U A R A N T E E D A S
WELL.
A L T H O U G H D E T E R M I N A T I O N OF THE F E D E R A L R E S E R V E ' S R E G U L A T O R Y
POLICY IS L A R G E L Y C E N T R A L I Z E D ,

ITS S U P E R V I S O R Y F U N C T I O N IS

C A R R I E D OU T A L M O S T W H O L L Y BY THE T W E L V E R E S E R V E BANKS.

THE

S Y S T E M H A S S U P E R V I S O R Y R E S P O N S I B I L I T Y FOR BANK H O L D I N G C O M P A N I E S
AND THEI R N O N - B A N K S U B S I D I A R I E S , STA T E M E M B E R BANKS A ND EDGE
C O R P O R A T I O N S , AS W E L L AS R E S I D U A L E X A M I N A T I O N A U T H O R I T Y FOR U.S.
BR A N C H E S AN D A G E N C I E S OF FO R E I G N BANKS.

THESE RESPONSIBILITIES

ARE CA R R I E D O U T T H R O U G H THE O F F I C E S OF THE R E S E R V E BAN K S A N D
TH EIR BRANCHES.
FINANCIAL STABILITY
HO W DOES ALL OF THIS TIE INTO M O N E T A R Y P OLICY?
HERE,

I THINK,

THE KEY

IS TO R E M E M B E R THE IN T I M A T E C O N N E C T I O N B E T W E E N TH E

M O N E T A R Y A G G R E G A T E S A ND THE I N S T I T U T I O N S T H A T C R E A T E THE BULK OF



-

TH E S E A G G R E G A T E S .

16

-

IN THE CASE OF Ml, FOR EXAMPLE , 72 P E R C E N T OF

THIS A G G R E G A T E R E P R E S E N T S T R A N S A C T I O N S D E P O S I T S OF D E P O S I T O R Y
IN STIT UTIONS.
INSTITUTIONS '

TH E S E D E P O S I T S A R E C R E A T E D IN TH E PROCE SS OF T H E S E
C R E D I T - G R A N T I N G A C T I V I T I E S AS TH E Y MAK E LOANS A N D

P U R C H A S E INV EST MEN TS.

IT IS D I F F I C U L T T H E R E F O R E TO S E P A R A T E

C O M P L E T E L Y THE RO L E OF BANK S AND OT H E R D E P O S I T O R Y I N S T I T U T I O N S AS
P R O V I D E R S OF M O N E T A R Y L I A B I L I T I E S F R O M THE I R R O L E IN CRE DITG RANTIN G.

THIS DUAL R O L E FOR BANKS SU G G E S T S THA T M O N E T A R Y P O LI CY

SHO U L D BE V I E W E D IN A BROA D CONTEXT:

AS ON E IN WHICH THE

N A T I O N ' S C E N T R A L BANK C O N D U C T S M O N E T A R Y PO L I C Y IN A M A N N E R THAT
PR O M O T E S THE S T A B I L I T Y A ND S O U N D N E S S OF F I N A N C I A L I N S T I T U T I O N S
AND MARKETS.

IN THIS CONTE XT, THE FE D E R A L R E S E R V E ’
S MONETARY

M A N A G E M E N T F U N C T I O N R E Q U I R E S I N T E R A C T I O N WI T H BANKIN G R E G U L A T I O N
A N D S U P E R V I S I O N AS SO U R C E S OF I N F O R M A T I O N AND EXPERTISE.
M O R E O V E R , R E G U L A T I O N AN D S U P E R V I S I O N CAN H A V E D I R E C T I MPA CTS ON
THE C E N T R A L BANK' S A B I L I T Y TO C O N D U C T M O N E T A R Y PO L I C Y B E C A U S E
THE Y I N F L U E N C E THE C H A N N E L S OF T R A N S M I S S I O N FOR M O N E T A R Y POLICY,
THE M E A N I N G OF THE M O N E T A R Y A G G R E G A T E S , A ND THE L I Q U I D I T Y A N D
S O U N D N E S S OF F I N A N C I A L INS TIT UT IONS .
THIS BROADE R C O N T E X T OF P R O M OTING F I N A N C I A L STAB ILITY,

IN

W H I C H MO N E T A R Y , R E G U L A T O R Y , A N D S U P E R V I S O R Y P O L I C I E S C O M E
TOG ETHE R,

IS P ERHAPS BEST E X E M P L I F I E D BY THE SY S T E M ' S R O L E AS

LE N D E R OF LAS T RESORT.

THE L I N K A G E S B E T W E E N THE T H R E E P O L I C I E S

A R E P A R T I C U L A R L Y I M P O R T A N T DURIN G P ERI ODS OF F I N A N C I A L S T R A I N
W H E N THE C E N T R A L BANK M A Y N E E D TO I N F L U E N C E THE D E C I S I O N S OF KEY
I N S T I T U T I O N S OR A S S I S T I N S T I T U T I O N S T H R O U G H THE D I S C O U N T WINDOW .
IN SUCH CASES, TH E R E S E R V E BA NKS A RE IN AN IDEAL P O S I T I O N TO M O V E



-

17

-

Q K I C K L Y IN TH E I R C A P A C I T Y AS LE N D E R S OF LAST R E S O R T TO A S S I S T
I N D I VIDUAL I N S T I T U T I O N S A ND EXERT A S T A B I L I Z I N G INF LUENCE ON
MARKETS.
T H E R E ARE M A N Y E X A M P L E S IN WHI C H THE R E S E R V E BANKS HAVE
H E L P E D TO AVERT, OR A T L E A S T ISOLATE, F I N A N C I A L CRISES.

SOME

T HA T COM E TO M I N D A RE THE FA I L U R E OF PENN C E N T R A L C O R P O R A T I O N IN
1970; THE F A I L U R E S OF F R A N K L I N N A T I O N A L BANK, H E R S T A T T BANK IN
GERMAN Y, A ND N U M E R O U S D E F A U L T S ON RE A L ESTATE I N V E S T M E N T TRUS T S
IN THE M I D - 1 9 7 0 S M E N T I O N E D EARLIER; THE F A I L U R E OF PENN S Q U A R E
BANK LAST SUMMER; A ND THE F A I L U R E OF THREE G O V E R N M E N T S E C U R I T I E S
D E A L E R S LAS T YEAR.

IN E V E R Y INSTANCE, R E S E R V E BANK A S S I S T A N C E

T H R O U G H THE D I S C O U N T W I N D O W FOR L I Q U I D I T Y P U R P O S E S PLAYED A KEY
R OL E IN C O N T A I N I N G THE S E PROBLEMS.
IV.

FEDERAL RESERVE FINANCIAL SERVICES

TH E R E IS A F O U R T H A R E A OF R E S P O N S I B I L I T Y OF T HE F E D E R A L
R E S E R V E SYS TEM IN W H I C H THE R E S E R V E BANKS PLAY THE KEY ROLE:

THE

PR O V I S I O N OF F I N A N C I A L S E R V I C E S TO D E P O S I T O R Y INS TITUTIONS.
UN TIL RECEN TLY , THE R E S E R V E BANK S P R OV IDED TH E S E S E R V I C E S --E.G.,
C HE C K P R OCESSING,

CA SH A N D S E C U R I T I E S S E R V I C E S A N D FU NDS T R A N S F E R

W I T H O U T C H A R G I N G A N Y E X P L I C I T FEES.

AS AN OFFSET, HOWEVE R,

M E M B E R BANKS W E R E R E Q U I R E D TO M A I N T A I N R E S E R V E S IN T HE FOR M OF
N O N - I N T E R E S T - B E A R I N G D E P O S I T S W I T H THE F E D E R A L R E S E R V E AND V A U L T
CASH THA T A V E R A G E D S U B S T A N T I A L L Y M O R E PER D O L L A R OF D E P O S I T S T H A N
TH O S E HELD BY N O N - M E M B E R BANKS.

AS A RESULT, TH E R E O C C U R R E D A

S I G N I F I C A N T D E C L I N E IN F E D E R A L R E S E R V E M E M B E R S H I P A N D
CONSEQUENTLY,
SUPPLY.




IN D I R E C T FE D E R A L R E S E R V E C O N T R O L OF THE M O N E Y

-

18

-

TH E D E P O S I T O R Y I N S T I T U T I O N S D E R E G U L A T I O N A N D M O N E T A R Y
C O N T R O L A CT OF 1980 (P O P U L A R L Y KNO W N AS THE MCA) C H A N G E D A LL OF
THIS.

TH E A C T M A N D A T E D A SET OF S T A G E D R E D U C T I O N S IN R E S E R V E

R E Q U I R E M E N T S FOR M E M B E R BANKS SPREAD OVER FOUR YEARS, W H I L E AT
TH E SAM E TIM E R E Q U I R I N G T H A T THE FED C H A R G E FOR THE S E R V I C E S IT
P R O V I D E D THESE INS TIT UTIONS .

THE A CT ALSO E X T E N D E D R E S E R V E

R E Q U I R E M E N T S IN S T A G E S OVER E I G H T YE A R S TO V I R T U A L L Y AL L
D E P O S I T O R Y IN STI TUTIONS,

BUT R E Q U I R E D TH A T THE FED GIVE T HESE

I N S T I T U T I O N S A C C E S S TO THE D I S C O U N T W I N D O W A N D TO ITS P R I C E D
SERVICES.

FINALLY, TH E C O N G R E S S INS IS TED ON P R O VI DING SOME

O F F S E T TO THE R E V E N U E LOSS THE T R E A S U R Y W O U L D SU F F E R B E C A U S E OF
THE LOWER ING OF THE A V E R A G E R E S E R V E RATIO.

IT R E Q U I R E D T H A T OVER

THE LONG RU N TH E F E D E R A L R E S E R V E C O V E R A L L D I R E C T A N D I N D I R E C T
CO STS INCURR ED IN P R O V I D I N G ITS PRIC ED SERVICES,

INCLUDI NG A

M A R K - U P TO TAKE A C C O U N T OF THE TAXE S A N D R E T U R N ON C A P I T A L T H A T
W O U L D HAV E TO BE C O V E R E D IF THE S E R V I C E S W E R E P R O VIDED BY THE
PR I V A T E SECTOR.
THE AIM S OF TH E S E C H A N G E S W E R E TO EN H A N C E M O N E T A R Y C O N T R O L
AND I MPROVE THE E F F I C I E N C Y OF THE N A T I O N ' S P A Y M E N T S N E T W O R K BY
S U B S T I T U T I N G E X P L I C I T PRICING OF SE R V I C E S FOR THE OLD,

INDIRECT

M E T H O D IN W H I C H BANKS IN E F F E C T PAID FOR CE N T R A L BANK S E R V I C E S BY
H O L D I N G R E L A T I V E L Y LARGE R E S E R V E BALANCES.

THROUGH EXPLICIT

CHAR GES , THE PRIC E OF B A NKING S E R V I C E S T H R O U G H O U T T HE E C O N O M Y
W O U L D M O R E A C C U R A T E L Y R E F L E C T TRUE R E S O U R C E COSTS.

W H I L E AI MIN G

FOR A M O R E EFF ICI ENT, R A T I O N A L P A Y M E N T S M E C H A N I S M , T HE A C T ALSO
R E C O G N I Z E D THE I N E S C A P A B L E R E S P O N S I B I L I T Y TH A T THE FEDE R A L




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19

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R E S E R V E H AS FOR THE S O U N D N E S S OF TH E P A Y M E N T S M E C H A N I S M A S W E L L
AS FOR E N SURING TH E O V E R A L L A D E Q U A C Y OF P A Y M E N T S SERVICES.
TH E D I S T R I C T BANKS OF T HE FE D E R A L R E S E R V E H A V E P E R F O R M E D
S E V E R A L I M P O RTANT F U N C T I O N S IN SA T I S F Y I N G TH IS DU AL A G E N D A OF
E F F I C I E N C Y ON THE O N E HAND, A ND SA F E T Y A N D A D E Q U A C Y ON T HE OTHER.
TO BEGIN WITH, TH E D E C E N T R A L I Z E D A D M I N I S T R A T I O N A L L O W E D BY THE
R E G I O N A L BANKS H AS P E R M I T T E D R E G I O N A L C O S T A N D M A R K E T D I F F E R E N C E S
TO BE A P P R O P R I A T E L Y R E F L E C T E D IN R E S E R V E BANK S E R V I C E PRICES.
LESS F L E X I B L E PRICI NG W O U L D H A V E R E S U L T E D IN A S I T U A T I O N LIKE
THAT FACED BY THE U. S. P OSTAL SYSTEM, W I T H M A S S I V E I N T E R R E G I O N A L
CROSS-SUBSIDIES.

THI S W O U L D H A V E M A D E NO M O R E S E N S E FOR TH E

F E D E R A L R E S E R V E THAN FOR ANY OTH E R I N S T I T U T I O N P R O V IDING P A Y M E N T S
S E R V I C E S IN A C O M P E T I T I V E MARKET.
THE U L T I M A T E PR ICES AN D M A R K E T SHA RES A R E FAR FR O M CERT AIN,
AS I N S T I T U T I O N S A D J U S T TO THE T R A N S I T I O N F R O M "FREE " FED S E R V I C E S
TO PRIC ED SERVICES.

BUT IT IS CLE A R THA T D E P O S I T O R Y I N S T I T U T I O N S

W IL L BE A B L E TO M A K E R A T I O N A L D E C I S I O N S A B O U T P U R C H A S I N G S E R V I C E S
F R O M R E S E R V E BANKS, OR C O R R E S P O N D E N T S , OR S E R V I C E BUREAUS, OR
PR ODUCING THE S E R V I C E S THEM SELVES.

AN D W I T H I N T HE F E D E R A L

R E S E R V E S Y S T E M ITSELF, THE A V A I L A B I L I T Y OF S E P A R A T E C O S T D A T A
F R O M T W E L V E R E S E R V E BANKS A L L O W S US TO M O N I T O R INTER N A L
E F F I C I E N C Y A N D KEEP C O S T S A P P R O P R I A T E L Y LOW.
T H E R E A R E MA N Y C H A L L E N G E S TO THE I M P L E M E N T A T I O N OF T H E
L E T T E R AND SPI R I T OF THE MCA.

THE A P P R O P R I A T E L O N G - T E R M R O L E OF

THE F E D E R A L R E S E R V E IN TH E A U T O M A T E D C L E A R I N G H O U S E ( A C H ) , FOR
EXAMPLE, AN D THE A P P R O P R I A T E PRI CES TO CH A R G E FOR ITS S E R V I C E S
H A V E BEEN M A J O R S U B J E C T S FOR DEBATE.



IN ADDIT ION , T HE P R I V A T E

-

20

-

SECTO R M U S T BE C O N V I N C E D THA T THE F E D E R A L R E S E R V E CAN
S I M U L T A N E O U S L Y SE RVE ITS R E G U L A T O R Y A N D S U P E R V I S O R Y F U N C T I O N S
W I T H O U T C O M I N G INTO C O N F L I C T WIT H ITS R O L E AS A PRO VIDER OF
F I N A N C I A L SERVICES.

ON THIS LAST POINT, WE H A V E BEEN C A R E F U L TO

E RE C T A " C H I N E S E W A L L , " AS IT WERE, B E T W E E N THE S E TWO SETS OF
A C T I V I T I E S SO AS TO AVOID,

FOR EXAMPLE,

EVEN THE S L I G H T E S T

S U G G E S T I O N THA T C U S T O M E R S OF OU R F I N A N C I A L S E R V I C E S W O U L D R E C E I V E
BETTER T R E A T M E N T AT THE D I S C O U N T WINDO W,

IN OUR EX AMINAT IONS, OR

IN OUR P R O C E S S I N G OF H O L D I N G C O M P A N Y A P P L I C A T I O N S .
CONCLUSION
IN SUMMARY, TH E FE D E R A L R E S E R V E SYS T E M IS M U C H LIKE OUR
N A T I O N -- L A R G E (IT H A S OV ER 23,000 E MPLOYEES), G E O G R A P H I C A L L Y
DIVERSE, A ND E N C O M P A S S I N G MA NY D I F F E R E N T E L E M E N T S AND P O I N T S OF
VIEW.

AS SUCH,

IT C O M B I N E S THE BE N E F I T S OF C E N T R A L I Z A T I O N OF

SOME F U N C T I O N S A ND D E C E N T R A L I Z A T I O N OF OTHERS.

THE F E D E R A L

R E S E R V E SE R V E S THE C O U N T R Y ' S M O N E T A R Y A N D F I N A N C I A L N E T W O R K IN
W A Y S TH AT W O U L D BE I M P O S S I B L E OR U N D E S I R A B L E TO C E N T R A L I Z E
CO MPLETELY.

IN TURN, TH I S R E S U L T S IN IM P O R T A N T POLICY A N D

A D M I N I S T R A T I V E R O L E S FOR TH E R E S E R V E BANKS.

THE B E N E F I T S OF

D I V E R S E V I E W P O I N T S AND THE N E E D TO R E C O G N I Z E R E G I O N A L D I F F E R E N C E S
ARGUE FOR D E C E N T R A L I Z A T I O N ,
I MPL EMENTATION.

BO TH FOR POLICY F O R M U L A T I O N AND

M Y I N T E N T I O N TOD A Y H AS BEEN TO SHA R E W I T H YOU

SOME OF THE R E A S O N I N G BE H I N D OUR F E D E R A L R E S E R V E STR UCT URE, A N D
TO A R G U E THA T TH IS STRUCTU RE, W H I L E IT MA Y A P P E A R S O M E W H A T
C O M P L E X OR EVEN B E W I L D E R I N G TO THE OUTSI DER ,

IS W E L L - S U I T E D TO

M E E T THE M A N Y R E S P O N S I B I L I T I E S THA T OUR N A T I O N ' S C E N T R A L BANK HA S




BEEN G I V E N A ND TO R E F L E C T THE U.S.
CH E C K S AND BALANCES.




P H I L O S O P H Y OF F E D E R A L I S M A N D