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Federal Reserve Bank of St. Louis

Statement by
Paul A. Volcker

Chairman, Board of Governors of the Federal Reserve System

before the

Subcommittee on Domestic Monetary Policy

of the

Committee on Banking, Finance


Urban Affairs

Bouse of Representatives

May 15, 1980

I am pleased to have the opportunity to present the views
of the Board of Governors on H. R. 7001, the proposed •Federal Reserve
Modernization Act• introduced by Chairman Reuss for himself and Chairman
Mitchell and Mr. Cavanaugh.

Chairman Reuss indicated in his introductory statement,

this bill was introduced the day after the Depository Institutions Deregulation
and Monetary Control Act of 1980 was signed into law.

I cannot let

this opportunity pass without expressing for myself and all the Members
of the Board of Governors our deep appreciation for the dedicated work
of your Committee, Chairman Reuss, Chairman St Germain and the other
members of the full Committee which resulted in this major legislative

'?his Act, particularly Titles I and II, the Monetary Control

Act of 1980, and the Dep.~sitory Institutions Deregulation Act of 1980,
will undoubtedly take their place among the most important pieces of

financial legislation enacted in this century.
The Monetary Control Act of 1980, strengthening the Federal

Reserve•s ability to implement monetary policy by providing an equitable
universal system of reserves for depository institutions, affords the
Board tremendous challenges and opportunities.

Although these provisions

are of overriding importance, they are only a few of the many changes
made by the new act that will require the careful attention of the Federal
Reserve Board.
Precisely because of the significance of these many amendments,
which involve new relationships mnong the Federal Reserve and depository
institutions, we would suggest first of all that it would be both appropriate
and highly desirable to allow a period of ti• to digest and assimilate
Federal Reserve Bank of St. Louis

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these changes before other legislative proposals to change the operations
or structure of the Federal Reserve System are pressed.

In particular,

we do not believe that the provisions of the Federal Reserve Modernization
Act can be of such urgency that they need to be considered by the Congress
on a priority basis while the Federal Reserve and the financial system
in general are involved in the orderly implementation of the Depository
Institutions Deregulation and Monetary Control Act of 1980.


a measure of experience under the legislation just passed would be helpful
in making any final legislative judgment.
More generally, our judgment is that the more radical changes
proposed in B. R. 7001 for the governance of the Federal Reserve would
have an undesirable and unsettling effect on the carefully constructed
structure for the implementation of monetary policy which has worked
well over the years.

Indeed, looked at not just section by section

but as a whole, we believe the net result, intended or not, could be
substantially to dilute both the independence of judgment and the regional
attributes that have, through the years, been characteristic of the
Federal Reserve System.
I would now like to turn to a discussion of the specific proposals
in H. R. 7001, beginning with the provisions of Title II.
Title II contains significant provisions dealing with structural
changes in the Federal Reserve System.

Sections 201 and 202 are interrelated.

Section 201 would abolish the Federal Open Market Committee and give
sole authority for the conduct of open market operations to the Federal
Reserve Board.
Federal Reserve Bank of St. Louis

It would remove the presidents of the Federal Reserve

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Banks from having any policy-deciding role in the formation of monetary


Section 202 would revise the Federal Advisory Council, by changing

the membership from each Federal Reserve district from a representative
of private industry selected by the board of directors to the president
of the Federal Reserve Bank for each district.

This would place the

presidents of the Federal Reserve banks in an advisory role to the Board
so far as open market policy questions are concerned.
The Board believes that both of these changes would detract
fr0111 the effective functioning of the Federal Reserve System.


its inception the Federal Reserve System has been based upon a combination
of c::entral and regional elements and fran a desire to insulate the System

fraa short-term and partisan political pressure.

Twelve Federal Reserve

Banks were established and given a significant role in the operation
of the System in order to assure a proper consideration of viewpoints
and needs from all sections of the country.

The premise was that all

wisdom does not reside in Washington, and that a degree of insulation

from iaaediate political considerations would be enhanced by an important
role for the Reserve Banks.
Removing the Reserve Bank presidents fran membership of the
Federal Open Market Ccaaittee would inevitably erode these objectives.
The Reserve Bank presidents and their research staffs not only bring
to the Federal Open Market Committee an element of experience, continuity,

and insight that might be lacking in a purely Washington based policymaking organization.

They also are an important source of knowledge

and informed opinion about regional interests and needs.
Federal Reserve Bank of St. Louis

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Inevitably, there would be a profound difference between an
advisory role, as contemplated by B. R. 7001, and the role of a participant
sharing responsibility for policy making.

Removal of the presidents

fr0111 the Federal Open Market Committee could only have the effect of
making the Federal Reserve more •washington• oriented, less sensitive
to regional concerns, and potentially without the same professional,
career commitment now characteristic of many of the Bank presidents.
I should note in this connection that Members of Congress have recently
expressed the view that the composition of the Board itself should be
more representative of regional and sectoral interests.

The proposal

in B. R. 7001 to reduce the role of the regional Reserve Bank presidents
in the conduct of monetary policy seems quite contrary to meeting that
overall concern.
The Federal Reserve System has also benefited fr0111 a unique
capacity within its structure to benefit fr0111 informed and constructive
criticism fr0111 those concerned with its operations and policies.


capacity would be weakened, in effect, by abolishing the Federal Advisory
Council as presently constituted.

That Council, consisting of leading

commercial bankers from each Federal Reserve district, provides an opportunity for the Board of Governors to obtain a considered point of
view of the economy and the credit conditions of the country.

It pro-

vides a channel for criticism and suggestions, ranging from broad policy
to operational concerns.

The insights gained have helped the Board

to implement policies and operations with more knowledge of their implications than would otherwise be possible.
Federal Reserve Bank of St. Louis

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We recognize the saae purposes could be approached in other

But, the question arises -- why e~ange an arrangement that is

functioning well and which the participants understand?

Is the purpose

to weaken the regional elements or the consultative processes in the

If not, what is it?
Section 203 would revise the provisions for the appointment

of Federal Reserve Bank presidents by removing the requirement of app~oval
by the Board of Governors of the Federal Reserve System and by requiring
that the presidents shall be bona fide residents of the district involved.
The Board appreciates the importance of independent minded
people serving as Bank presidents, individuals able to participate in
policy and operations alongside Board members.

We also believe that

while the initiative and choice lies with the regional boards, some
review of the appointment by public officials is an essential part of
the appointment process given the nature of the duties.

We know of

no better way to accomplish that result than the arrangements embodied
in the Federal Reserve Act for almost 70 years.

In that connection,

we note the importance of mutual respect and an ability to interact
harmoniously between the Board and the presidents of the Federal Reserve
With respect to residency, the Board agrees that, and it has
been a practice for, the president of the Federal Reserve Bank to be
a bona fide resident of the district.

However, we would oppose a requirement

for residency prior to employment because it would detract fran the
ability to obtain individuals of the highest caliber for the posts,
Federal Reserve Bank of St. Louis

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including our ability to attract career people to the Federal Reserve
who might conceive of moving from one district to another as an avenue
for promotion and development.
Section 204 provides that the Federal Reserve System shall
utilize its resources, and generally conduct its affairs, to foster
the policies and purposes of the Employment Act of 1946, and the Full
Employment and Balanced Growth Act of 1978, particularly the nation's
effort to achieve a stabler price level and an improved economic structure.
The Board is unclear on the intent of this section.

The Board

now accepts the Employment Act and the Full Employment and Balanced
Growth Act as guiding principles.
price stability.

We are, of course, concerned with

In these respects, the addition of this section would

not appear to be necessary.

However, the section speaks specifically

to the System using its resources to improve the nation's economic structure.
We are uncertain as to the meaning, and would desire further .clarification,
of this proposed charge to the System.
I would now like to address the provisions of Title I which
would provide for the retirement of Federal Reserve stock and substitute
a certificate of membership for stock ownership.

In connection with

previous proposals for retirement of Federal Reserve stock, the Board
has advised this COJD11ittee that on balance it believed that ownership
of Reserve Bank stock is desirable because of the tangible indication
it provides of the interest of its members in the operations and efficiency
of the System.
Federal Reserve Bank of St. Louis

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Chairman Reuss has suggested that the provisions of the Monetary
Control Act of 1980 make the present st~ck requirements for member banks

While it is true that the rights attached to ownership

of stock in a Reserve Bank are, in fact, extremely limited, that does
not dispose of the question.

Voluntary membership still has an important

role to play in the Federal Reserve System.

Members elect some of the

directors of the Federal Reserve Banks who, in turn, elect the Bank
presidents and maintain surveillance over the efficiency and effectiveness
of Reserve Bank management and operation.

In those respects, the public

and private interest broadly coincide, and the participation of able
men and women as directors, included among them persons chosen by stockholding members, I believe contribute importantly to our efficiency
and operational effectiveness.

The Board would not wish to see any

changes made that would weaken either its ability to attract outstanding
individuals as directors of the Federal Reserve Banks and branches,
or their continuing dedication to their work.

However attentuated the

rights of a stockholder may be compared to a normal corporation, that
tangible evidence of continued interest we believe helps enhance our
ability to obtain qualified independent minded directors concerned and
interested in the effectiveness of the System.
In this connection, the provisions of H. R. 3257, a bill you
have sponsored, Mr. Chairman, would increase the number of Class C directors
appointed by the Board and thus permit the Board to increase the representation
on the boards of directors of conswners, labor and service interests.
We believe this approach is appropriate.
Federal Reserve Bank of St. Louis

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I recognize that some directors could continue to be elected
by members holding only a "membership certificate.•
Banks are corporations, and do have capital.

But the Reserve

The alternative, presumably,

would be in effect to transfer the stock evidence of that capital to
a government agency.

But what would be achieved by such a change?

Would it not, whatever is intended, lead to an implication or allegation
of Treasury control? Would it not, again whatever is intended, weaken
the healthy concerns of banks with how the Fed is managed?


do believe that consideration also needs to be given to

the participation of nonbank financial institutions on the boards of
the Federal Reserve Banks1 whether they should participate in the election
of directors, and, if so, how this should be accomplished.

We also

recognize that limiting payment of the dividends to 6 per cent on Federal
Reserve stock can be a small disincentive to membership, and if it is
concluded that membership should be broadened and stock retained, consideration
might also be given to providing a rate of return on that stock more
comparable to that on government securities.

Considerations of this

sort lead us to the conclusion that elimination of Federal Reserve stock
would be undesirable, but that consideration of which institutions might
be eligible for membership, the formula for acquiring such stock, and
the rate of dividends will be in order as we gain experience with the
Monetary Control Act of 1980, and its impact on the Federal Reserve
The provisions of H. R. 7001 do not change the role of the
Federal Reserve System with respect.;tO:the supervision and examination
Federal Reserve Bank of St. Louis

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of member banks.

However, in Chairman Reuss' introductory statement,

he said •Chartering and examination of S~ate banks, member and nonmember
alike, would reside in the State regulatory agencies rather than the

In view of this statement, I would be remiss if I did not address

the subject of the role of the Federal Reserve in the supervision and
examination of member banks.
The Board has stated on a number of occasions that it believes
that the condition of the banking system and information about individual
banks is an important input for monetary policy formulation which would
be lost or substantially reduced if the Federal Reserve had no role
in the regulation or examination function.

Our experience in recent

years has only served to strengthen the conviction that information
which the System obtains in the course of exercising its supervisory
functions provides key insights into such matters as the state of liquidity
and viability of the nation's banking institutions, indispensable elements
in the formulation and implementation of monetary policy.

The borderline

between monetary, regulatory, and supervisory powers is sometimes indistinguishable.
We believe all would be weakened by trying to enforce a strict separation.
Obviously, there are a number of issues in the relationships among supervisory
agencies, some of which have been addressed in recent legislation.
As we gain experience under that legislation, we may have further proposals.
But the Board strongly recommends that it continue to have a role in
this area, and that the Board retain responsibilities for supervision
and examination.
Federal Reserve Bank of St. Louis

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In summary, Mr. Chairman, the Board is concerned that the
proposed structural revisions would weaken certain traditional elements
in the Federal Reserve structure that significantly and substantively
have contributed to the independence, the regional balance, and the
efficiency, effectiveness, and integrity of our operations.
However, we do agree further consideration of the nature of
membership and eligibility and terms of stock ownership in the Federal
Reserve System will be needed in light of the enactment of the Monetary
Control Act.

Attention should be given to the participation in the

ope-rations of the Federal Reserve Banks by nonbank financial institutions
that will maintain reserves with the Federal Reserve, as well as their
representation on the boards of directors of those banks.

And we continue

to feel that those boards should be expanded in size in order to accommodate
a broader representative segment of the public as a whole.
As experience has been gained under the Monetary Control Act
of 1980, we will be happy to work with you and your Committee and its
staff in evaluating and developing possible legislative proposals that
might acCOIIIIIOdate these needs.
Federal Reserve Bank of St. Louis