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The Federal Reserve as a Democratic Institution
The Hutchinson Lecture
University of Delaware
Newark, Delaware
April 28, 1999


or quite some years, I have been fascinated by the issue of what we mean by
a “democratic institution,” especially
in the context of a nation’s central bank.
As you might suspect, my interest in this subject
has increased since I came to the Federal Reserve
Bank of St. Louis last year.
Historically, some central banks have enjoyed
considerable independence from the elected
national government. Leading examples are the
central banks of the United States, Germany and
Switzerland. In recent years, the United Kingdom,
Japan, New Zealand and a number of other countries have increased the independence of their
central banks and required greater disclosure of
central bank operations and plans. The charter
for the new European Central Bank, charged with
managing monetary policy for the euro, provides
for great independence. Evidence on central bank
performance in a variety of institutional settings
suggests that independence improves results;
this evidence has had much to do with decisions
by many countries to increase the independence
of their central banks.
Does central bank independence mean that
societies have backed away from democratic
control of this important institution, or does
independence in fact increase democratic control?
In our country, the question is: Just how democratic is the Federal Reserve System?
I will assume, for now, that central banking
is inherently a governmental function. Federal
Reserve Banks actually have a mixed public/
private status under U.S. law, but given that the
controlling statute is the Federal Reserve Act, I
will ignore the public/private complications and

simply assume that the Fed is a governmental
Before proceeding, I want to emphasize that
the views I express here are mine and do not
necessarily reflect official positions of the Federal
Reserve System. I thank my colleagues at the
Federal Reserve Bank of St. Louis for their comments, but I retain full credit for errors.

I am an economist, not a political scientist,
and so my analysis reflects the perspective of an
economist. Political scientists, however, have
not written extensively on the Federal Reserve
System; I think it fair to say that of important
U.S. political institutions, the Federal Reserve is
easily the most neglected in the political science
literature. If I am mining deposits that rightfully
belong to a different discipline, it is not because
economists are imperialists, but because important
issues have not been adequately examined by
that other discipline.
When I studied American history in high
school, an important topic was the development
of our nation’s democracy. What I especially
remember about democracy from those days,
however, are the lessons my teachers taught about
democracy from our own exercise of electing class
officers. When running for office, we stated our
positions on school matters. Our teachers taught
us that the essence of democracy is voting. But,
amazingly enough when you think about it, they
also taught us that it was unseemly to actually
campaign for office.


Over the years, I came to appreciate just how
wrong that teaching was. Voting means nothing
without information and the competition of ideas.
And what sort of democratic control do we really
have through the ballot box when there are only
two candidates but dozens of issues?
We live in a complex society. Direct democracy—voting on each and every issue in the style
of a New England town meeting—is not feasible.
In any given political campaign, we find that 10
or 20 issues are actively discussed. At the federal
level, the government administers hundreds upon
hundreds of programs of many different kinds.
What we mean by democratic control over the
government certainly does not mean that each of
these programs is somehow controlled and disciplined by the voters at each election. We necessarily vote for our national leaders on the basis
of a handful of specific issues and a generalized
view about the candidates’ qualifications to direct
the administration of the vast enterprise of
Clearly, then, the issue of democratic accountability of any particular agency does not depend
on the agency head being elected. In our federal
system, only the President of the United States is
elected by the entire electorate. The President
appoints key officials, most subject to Senate
confirmation. Following this standard pattern,
the President appoints, and the Senate confirms,
members of the Board of Governors of the Federal
Reserve System.
Is appointment by the President and confirmation by the Senate all we mean by a democratic
institution in the United States? I think not—I
am convinced not—and that is my subject this

I’ll begin by briefly outlining the Federal
Reserve’s current governance structure. And I
ask you to bear with me for about two full minutes
of detail on who appoints whom when. The
President appoints the seven members of the

Board of Governors of the Federal Reserve System;
each member has a 14-year term. A term expires
every other year. A member may serve one full
14-year term, or a partial term when a vacancy
arises followed by a full 14-year term upon
reappointment and Senate confirmation. Once
appointed, a member may not be removed by the
President but only through the impeachment
process defined in the Constitution.
The President appoints the chairman of the
Board of Governors from among the seven members. The chairman serves a four-year term, which
begins upon Senate confirmation. The chairman
can be reappointed during his term as a governor.
Twelve Federal Reserve Banks are scattered
around the country. Each has a president selected
through a process I will describe in a moment.
The Reserve Banks are operational centers for
Federal Reserve activities involving such services
as handling currency, clearing checks and supervising banks.
In broad outline, each Federal Reserve Bank
has a legal organization similar in many respects
to that of any other corporation. A Reserve Bank
is governed by a board of directors, subject to
general oversight by the Board of Governors and
the requirements imposed by Congress in the
Federal Reserve Act.
When a Reserve Bank presidency becomes
vacant, the Bank’s board of directors conducts a
search and screens candidates in the usual fashion.
After that, in typical Federal Reserve fashion,
the process gets a little more complex. The law
provides for a check and balance—the Federal
Reserve Act vests the Bank’s board with power
to appoint the president, but gives the Board of
Governors power to approve the appointment.
Thus the local board, with its mix of public and
private interests, plays a major role, but its discretion to act is kept in check by the need to secure
approval of the appointment from the Board of
Governors. Suffice it to say that both boards take
their respective roles in the process very seriously.
Once appointed, a Reserve Bank president serves
at the pleasure of the Bank’s board and may be
removed for cause by the Board of Governors.

The Federal Reserve as a Democratic Institution

The Reserve Bank president is the chief
executive officer and has the typical corporate
responsibility of administering the Bank’s operations. The Bank president also sits on the Federal
Reserve’s main policymaking body, the Federal
Open Market Committee. The voting membership
of that committee is the seven members of the
Board of Governors and five of the twelve Reserve
Bank presidents. The president of the Federal
Reserve Bank of New York is always a voting
member, and the other four voting members serve
on a rotating basis from among the other eleven
Reserve Banks. In my case, for example, the vote
rotates every three years among the presidents of
the Federal Reserve Banks of St. Louis, Dallas,
and Atlanta.
Where do the Reserve Bank boards of directors
come from? Each board consists of nine members.
A board member serves for a three-year term,
which can be renewed for an additional threeyear term. Six of the nine members are elected
by the member banks within the Federal Reserve
District; the other three are public members recommended by the local Federal Reserve Bank
and appointed by the Board of Governors in
Washington. The board of director’s chairman
and deputy chairman are drawn from the three
public members and named by the Board of
Still with me? I hope so. The governance
structure I have just described is, I believe, a
source of great strength for the Federal Reserve
System and a source of heightened democratic
accountability compared to an arrangement in
which, for example, the central bank is a cabinet
department or subsidiary unit of the Treasury. I
thought that before I came to the St. Louis Fed,
and I think it now. The issue I want to explore is
why this arrangement—which appears to be far
removed from our usual model of democratic
accountability—is in fact so successful.

To analyze the best form of political organization for any governmental entity, we need to be

clear about the responsibilities of that entity. What,
exactly, is the Federal Reserve supposed to do?
Central bank responsibilities are not the same
in all the countries of the world. Arrangements
for operating the payments system and supervising
banks vary from one country to another. Clearly,
though, the essential central bank responsibility
is control over monetary policy. While some
countries can operate their monetary system by
tying their currencies closely to the U.S. dollar
or some other currency, U.S. monetary policy is
not tied to an external standard. Before 1933, the
Federal Reserve did conduct monetary policy by
adhering to an external standard—the gold standard. Now, the U.S. dollar is pure fiat money,
whose purchasing power is determined by the
Fed’s decisions and their interactions with the
U.S. and world economies.
The Federal Reserve’s prime responsibility is
to maintain the purchasing power of the U.S. dollar and the stability of the aggregate U.S. economy. To maintain the purchasing power of the
dollar, the Fed must regulate the supply of dollars so that it matches the demand for dollars at
a stable price level, or a low and steady rate of
inflation for those who prefer to put the policy
goal that way.
The Federal Reserve, working closely with
parts of the government like the U.S. Treasury and
the Federal Deposit Insurance Corporation, is
responsible for safeguarding the banking system
and ensuring the smooth and reliable operation
of the payments system. The Fed distributes currency to the banks as they require it to meet their
depositors’ needs. The Fed pulls suspected counterfeit bills out of circulation and turns them over
to the Secret Service for verification and investigation. Most of us forget how important this function is; think of how chaotic your everyday life
would be if you could not accept as a matter of
course that the paper money you use is reliable
and not subject to refusal because of fear of counterfeit bills? Extending this responsibility, the Fed
oversees the banking system so that deposits
can be used reliably and payments can be made
cheaply and on schedule through paper check
and electronic funds transfer mechanisms. In


short, an essential part of the infrastructure of a
modern economy is the complete reliability of
the payments mechanism and settlement system.
Everyone must be able to make and receive payments reliably. Such reliability is as important to
everyday life as a reliable supply of electricity.
Over a period of many years the Federal
Reserve has developed extensive expertise in
operating the payments system. There are many
fascinating issues in this area, such as the continuing transition from paper-based payments to
electronic payments. There are issues of efficiency
and cost. With the odd exception of current concerns over the Y2K issue, however, these issues
don’t occupy the front pages of newspapers, or
even the front pages of business sections of
The most important bank regulatory issue still
outstanding—one that could hit the front pages—
concerns the problem of “too big to fail.” This is
the issue of how best to approach the problem of
very large banking organizations whose failure
could be highly disruptive to the economy. If such
firms are propped up by the government, then the
spur to efficiency and proper evaluation of risk
that arises from the risk of failure is removed.
Although the payments system and banking
issues are important, they do not routinely appear
in the daily news. What is regularly in the news
is general monetary policy. Because of the importance of the Fed’s policy responsibilities—a central
bank’s control of money creation and interest
rates have large effects on the rate of inflation
and the overall stability of the economy—these
issues often appear in the political debate. Given
that monetary policy decisions have such profound effects on society, it is perfectly natural
and fully appropriate that we debate the way we
exercise political control over the central bank.

I have so far taken for granted that central
bank functions are inherently public. We should
recognize, however, that many activities essential

to daily life are organized in a market economy
without the government taking primary responsibility. For example, the production and distribution of food, though influenced by government
policies, is left almost entirely to the market.
The fact is that we do not rely on government to
put food on the table, and there is no reason to
believe that the government could produce a
cheaper and more wholesome food supply than
the market economy does.
Economists have traditionally viewed control and regulation as an inherently governmental
function. However, a few economists have argued
that the government should exit the money business and leave the creation and management of
money entirely to the private market. This subject is fascinating in its own right, but today I
merely want to state my conviction that the traditional analysis is correct—the creation and
control of money should remain a governmental
Why, briefly, is money a government responsibility? The crux of the matter is not that money
is especially important —food is also important,
but the production and distribution of food works
well in the private competitive market economy.
The creation and distribution of money involves
important “external effects,” as economists call
them, that prevent a market solution from working
satisfactorily. Let me illustrate this point by referring once again to counterfeit money. It is hard
to see how a competitive market system would
work to remove counterfeit bills from circulation.
Anyone who inadvertently accepts a counterfeit
bill has an incentive to pass the bill along to someone else rather than remove it from circulation.
Removing the counterfeit provides a benefit to the
society as a whole, but at a cost to the individual.
Market exchanges work well when both parties
benefit. When I buy apples at a roadside stand,
the farmer and I both benefit from the transaction.
When I remove counterfeit currency from circulation, society benefits, but I lose. For this reason,
it is optimal for society to provide a government
agency to assume responsibility for monitoring
the quality of the currency and removing counterfeit and unfit bills for everyone’s benefit. The

The Federal Reserve as a Democratic Institution

Fed charges counterfeit bills back to the banks
that send them to the Fed, but this procedure is
part of the enforcement mechanism and far from
voluntary on the part of the banks.
This same principle applies to many other
central bank activities. The governmental function provides benefits for the society as a whole
that private market participants do not have the
incentive to perform.

I have argued that central bank responsibilities
are inherently governmental. How, then, should
we organize political control over the central bank?
The pattern in many countries historically
was for the central bank governor to report to the
treasury or finance ministry and for the governor
to serve at the pleasure of the head of government.
That was never the pattern in the United States.
From its establishment in 1913, the Federal
Reserve was an independent agency not subject
to tight, everyday control by the President or the
Secretary of the Treasury.
What I want to do now is analyze three considerations that are relevant to the issue of how
best to organize political control over the central
bank. These three issues concern the length of the
political horizon, the time consistency problem
and the advantages of single-purpose agencies.

Length of the Political Horizon
We often hear people say that one reason for
central bank independence is that the political
process inherently has a short horizon, extending
at best to the date of the next national election, or
perhaps the next presidential election. I am not
convinced by this argument. My observation is
that the political process is often, but not always,
shortsighted. Our society in fact makes enormous
investments in the future through government.
Government taxes support schools, highways,
national parks, a defense establishment and many
other activities that have payoffs over years span-

ning many electoral cycles. Yes, we do see cities
that pave streets and pick up trash just before a
mayoral election. But I admit that I straighten up
my house and rake the yard just before a party!
I note that some analysts accuse corporations of
shortsighted behavior in trying to pump up nearterm earnings. In short, although all of us suffer
from time to time from a compressed horizon that
pays too little attention to the long-term consequences of our behavior, I do not believe that
short horizons are an inherent feature of government behavior. When voters and their elected
representatives understand the need for a long
horizon, I believe that our political process can
deliver the correct policies.

The Time-Consistency Problem
I’ll illustrate the nature of the time-consistency
problem by using an example directly relevant
to monetary policy. Suppose a government were
to promise everyone that the central bank would
pursue a permanent policy consistent with zero
inflation. If the government were successful in
convincing people that the inflation rate would
be zero, then long-term bond rates would fall to
a level consistent with that expectation. Suppose
that interest rate would be 3 percent. The government could then issue 100-year bonds and retire
all its short-term debt. By doing so, the government would lock in the 3 percent interest rate for
a very long time.
Having refinanced its debt this way, the government might be subject to the temptation to
permit a certain amount of inflation. With 5 percent inflation, the real interest paid on the bonds
would be minus 2 percent—the 3 percent money
interest would not even cover the inflation rate.
In the market, the interest rate on new debt might
have to rise to 8 percent—5 percent to cover the
inflation and 3 percent to reflect the real rate of
interest. Clearly, it could well be in the interest
of the government to create inflation once all of
its debt had been locked up in 100-year bonds
at 3 percent. Such a policy is said to be “timeinconsistent”; what is optimal given what has
already taken place and given the expectations


created by the promise to create zero inflation is
not optimal as a repeated matter from the beginning. Should everyone be aware that the government is going to follow a policy of 5 percent
inflation, then the government could never have
issued the 100-year bonds at a 3 percent interest
rate in the first place.
In a democratic society, we certainly want
political arrangements that encourage actions that
are optimal when followed consistently over time.
Some of the characteristics of government that we
expect to be maintained consistently over time
are incorporated in the Constitution itself. These
provisions bind all administrations, whenever
elected, and help to avoid the time-inconsistency
There was a time in our history when adherence to the gold standard had the characteristic
of a constitution-like provision. In the end, the
gold standard did not prove to be a satisfactory
monetary system and the country abandoned that
arrangement. However, we have not put in place
a constitutional or constitution-like monetary
standard to replace the gold standard. We continue to be faced with the possibility that any
particular administration may find it in its shortrun interest to pursue monetary policies that are
not in the country’s long-run interest. This fact is
an important underpinning of the case for a degree
of central bank independence from the administration in power. It makes no difference whether
the administration is Democrat or Republican, for
every administration is subject to the same underlying realities that policies designed for the shortrun may not be optimal for the long run.

Advantages of Single-Purpose Agencies
An important problem voters face in choosing
between two candidates is that the number of
issues on which the candidates differ may be
quite large. The vote for a particular candidate is
always a compromise, no matter how superbly
qualified a candidate is. Each of us has surely
had the experience of being enthusiastic about a
candidate but understanding that on some issues
the candidate does not reflect our own views. We
vote based on our view as to which candidate is

the best compromise.
Because the government faces an enormous
number of issues at any one time, each elected
official must craft compromise positions and
decide which issues need to come out which way.
An elected official understands full well that a
vote will cost support among some constituents
and gain support among others. An official needs
to support positions in such a way as to construct
a coalition among voters sufficient to gather
enough votes at the next election to remain in
For the voters, an important advantage of a
single-purpose agency is that the voter need not
trade off views on that agency against views on
policies followed by other agencies or areas of
governmental responsibility. Unlike a member of
Congress who may find himself trading off various
policy concerns that have no inherent relation to
each other, a single-purpose agency can be judged
by the voters against its single responsibility. The
Federal Reserve approximates a single-purpose
agency. The Fed is the only agency that is responsible for the average rate of inflation in the
economy over the long run; of course, short-run
fluctuations in inflation are beyond the Fed’s
control, but the long-run trend of inflation is the
Fed’s responsibility and the electorate can and
should judge the Fed on its performance in that
This clear focus of responsibility has a great
advantage in a democratic society. In my opinion,
the Federal Reserve’s substantial independence
from the political process realizes that advantage
to the maximum possible extent and is an element
of great strength in U.S. political arrangements.
If something goes wrong with the inflation rate,
the electorate knows who is responsible and can
identify the nature of the appropriate response.
The President can appoint different leadership
to the Federal Reserve by exercising his power of
appointment every two years when a term on the
Board of Governors expires. In contrast, if the
Federal Reserve were set up as a cabinet department along the lines of the Treasury Department,
voters would have to judge the severity of the
inflation problem against all other dimensions of

The Federal Reserve as a Democratic Institution

the President’s responsibility.
I also believe that the regional focus of the
appointment process of Reserve Bank presidents
reinforces central bank independence. It is important to realize that the Reserve Bank president is
chosen through a regional process but is not particularly a regional representative. Reserve Bank
presidents all understand that monetary policy
is a national matter; we do not have regional
monetary policies. My own example is instructive.
I had no ties to the Eighth Federal Reserve District,
except for an intellectual kinship reflecting my
own education at the University of Chicago and
the importance of Chicago-school economics at
the Federal Reserve Bank of St. Louis since the
late 1950s. The appointment process through
Reserve Bank boards of directors rather than
through political processes in Washington or
state capitals buttresses the nonpolitical and
independent status of the Federal Reserve.

I am sure that you agree that the high school
view of democracy I described at the beginning
of this lecture is extremely incomplete. It is, of
course, essential that we be able to vote for our
leaders holding elective office, but far from adequate to simply vote for the good guys and against
the bums. Every one of us has experienced tremendous frustration in trying to deal with government
agencies. These agencies, I emphasize, are established by laws written by our elected representatives and administered by elected executive
officers—the President, a governor, a mayor. All
too often we find such agencies to be unresponsive to our inquiries and secretive about their
What makes for a high-performing government
agency? I believe that we want each agency to be
responsive to those for whom the agency provides
services. We want the agency to be open to criticism. We want the agency to explain its policies
and practices. These are essential characteristics

of accountability in a democratic society. Indeed,
without these, the method for naming an agency
head means little.
Would it make sense for the national electorate
to vote directly to choose the chairman of the
Federal Reserve System and 10 or 20 other key
agency heads? I don’t think so. I believe that the
current method of selecting Fed leadership works
well. The Board of Governors heads the Federal
Reserve System, and the board’s members are
appointed by the President and confirmed by the
Senate. The regional Federal Reserve Banks have
leadership selected by local boards of directors
drawn from the communities all over the United
States. The diversity of methods to choose Fed
leadership provides, I believe, a diversity of views
and serves as a great source of strength for the
central bank in the United States.
The Federal Reserve, I believe, ranks far up in
our nation’s list of agencies in terms of responsiveness and openness. The Fed is close to the
constituents it serves by virtue of numerous
meetings of advisory boards and programs out in
the Federal Reserve Districts. I travel extensively
throughout the Eighth Federal Reserve District,
meeting with groups of bankers, business and
community leaders, newspaper editors and
elected officials. We have frequent meetings of
advisory groups at the main office in St. Louis.
Our three Branches in Memphis, Louisville and
Little Rock have many contacts with their local
communities. The Fed provides numerous publications aimed at both professional audiences
and community and lay audiences.
In addition, members of our operating staff
in check clearing, electronic payments and currency-handling operations meet frequently with
those for whom they provide services. Bank supervisors and examiners meet frequently with banks
not only in the context of bank exams themselves
but in more general contexts.
An element of Reserve Bank accountability
not well understood by the general public, or
even by public finance experts, stems from the
Monetary Control Act of 1980. That Act requires
the Fed to charge for many of its services at cost.
Federal Reserve Banks compete with private firms


in check-clearing; indeed, the Fed has about one
third of this business and the private market two
thirds. Most governmental agencies providing
services in competition, or potential competition,
with the private sector have their positions protected either by grants of monopoly power or by
substantial subsidies that permit the government
agencies to charge prices far below cost. The
requirement that the Fed price services at cost
imposes a market discipline that supplements
political accountability.
At the national level, Fed governors are frequently seen on Capitol Hill providing testimony
on a wide variety of subjects. The chairman’s
testimony receives wide coverage in newspapers
and on television. I think it is fair to say that anyone who desires contact with the Fed has many
opportunities to raise questions and comment
on what the Fed does.
My observation, certainly now and I honestly
believe before I came to the Federal Reserve Bank
of St. Louis, is that the Federal Reserve is more
open than any other agency of government. A
striking feature of the Federal Reserve System is
that a substantial degree of difference of opinion
on monetary policy issues is on open display. The
Federal Open Market Committee voting system
provides for formal dissenting views and an
accompanying paragraph in the minutes explaining the reason for the dissent. Fed publications
from the Board of Governors and the Reserve
Banks often display differences of views on controversial matters. The press refers to certain
members of the FOMC as “hawks” or “doves.” I
believe that all of us in the Fed are engaged in a
common effort, but we are not bashful about airing
how our views may differ on how to reach the
common objective. We do have professional differences that match differences on monetary policy
among academic and business analysts. When


people talk to me about internal debates, I always
say that you can assume that all of the debates
you see on the outside are also conducted on the
In short, the Federal Reserve is an extraordinarily healthy and productive organization. I
believe that the Fed’s degree of democratic
accountability is extremely high. The Fed is
responsive, open and approachable. It maintains
high standards of accountability and integrity
in its internal operations and the separation of
personal financial gain from access to inside

For me, the key question of the Federal
Reserve’s democratic accountability is whether
tighter control by elected officials would improve
that democratic accountability. I am convinced
not. I believe that the present openness and
healthy internal debate would not survive intact
if the Federal Reserve were more tightly controlled
by the elected national administration. If the Fed
were organized as a cabinet department, I believe
it inevitable that certain compromises with monetary policy would be struck as a part of the normal
process of building coalitions, striking compromises across different areas of government. The
fact that the Federal Reserve is essentially a singlepurpose agency with a significant degree of
independence from day-to-day political considerations provides for a clear locus of responsibility
and a clear agency objective.
It is often said that the Federal Reserve is
independent within the government, not independent of the government. I am convinced that
the Fed’s structure, far from impairing political
accountability, enhances it.