John Dearie is a former officer of the Federal Reserve Bank of New York.
By John Dearie
The Fed, after all, is more than a century old. Although details of its operation have been tweaked over the years, it has not undergone significant reform or modernization since Congress created it in 1913, despite dramatic changes in technology, the complexity of the U.S. economy, and the size and demographics of the nation.
In fact, there is a simple and long overdue change that would instantly make the Fed more accountable to many more Americans and monetary policy more responsive to our large and highly diverse economy: opening two new reserve banks in western U.S. cities.
The Federal Reserve Act of 1913 established a decentralized system of 12 regional reserve banks, coupled with a seven-member board of governors in Washington. This messy, cumbersome structure was deliberate and inspired — designed to achieve two important objectives: (1) ensuring that financial policy decision-making would not be concentrated in Washington; and (2) making sure that monetary policy would incorporate and reflect economic conditions and priorities across a vast and economically diverse nation.
Thirty-seven cities applied to host a reserve bank, and politics, as always, played a role in the selection process. Sen. James A. Reed of Missouri, a prominent Democratic member of the Senate Banking Committee, managed to win two for his state, in Kansas City and St. Louis. Even so, the locations of the 12 banks generally reflected the distribution of the country’s population and economic activity at the time.
The result was a system with a decidedly eastern tilt. Nine of the 12 regional reserve banks are either on or east of the Mississippi River, and six are within 600 miles of Washington. Meanwhile, 1,700 miles separate the San Francisco Reserve Bank from the next closest one in Dallas.
The United States has changed dramatically since 1914. According to Census Bureau figures, 42 percent of the U.S. population — and, presumably, a similar portion of economic activity — now resides west of the Mississippi River. This suggests that if the interests and priorities of the entire nation are to be represented in monetary policy deliberations, then at least five of the 12 reserve banks should be in western cities. Simply stated, American citizens and businesses in western states don’t have the voice in monetary policy-making they deserve.
Given the political improbability of uprooting and relocating an existing reserve bank, a better option is to expand the number from 12 to 14. The current distribution of the U.S. population suggests that cities in the Southwest and Pacific Northwest would be appropriate locations, perhaps Phoenix and Seattle.
The Federal Open Market Committee (FOMC) — the Fed’s monetary policy body, created by the Banking Act of 1933 — should also be amended to reflect the expansion. The FOMC is composed of the seven Federal Reserve Board governors, the president of the Federal Reserve Bank of New York, which presides over the nation’s financial center, and the presidents of four of the remaining 11 reserve banks on a rotating basis. Once the two new western banks are added, the number of voting reserve bank presidents should be increased from the current five to seven, which would be half of the reserve bank presidents at any given time. This would produce a 14-member FOMC split evenly between the Washington-based board of governors and the rotating reserve bank presidents.
The net effect would be a 40 percent increase in the role and influence of the presidents of the regional reserve banks, who represent the priorities of U.S. citizens and businesses across the nation in monetary policy deliberations. These simple reforms would go a long way toward modernizing the century-old Federal Reserve and ensuring a central bank better suited to serving all Americans. A bank for the 21st century.
