Federal Reserve Reform

The Federal Reserve System was first established over 100 years ago with the advent of The Federal Reserve Act in 1913. While the landscape of the United States has changed significantly in that time, the formal structure of the Fed System has stayed remarkably the same. And while the Federal Reserve was initially created in response to a series of bank runs and financial crisis, we should leverage this most recent financial crisis as an opportunity to put forward structural changes that can help expand the scope of the Fed as well as ensure further political insulation.

The current Regional Federal Reserve bank system is the same structure that it was when it was founded in 1913. At this time, the US population was most heavily concentrated in the Eastern portion of the country and, with a population of approximately 97 million people, each Federal Reserve oversaw an average of approximately 8.1 million Americans. The population changes over the 100-plus years since is the underlying argument for change as proposed by John R. Dearie in his WSJ article The U.S. Needs Two More Federal Reserve Banks. He points out the US has undergone a great change in its population make-up:

The Census Bureau has estimated that as of 2014, 42% of the population—and, presumably, a similar portion of economic activity—resides west of the Mississippi River. This simple metric suggests that if the interests and priorities of the entire nation are to be represented in monetary policy deliberations, at least five regional Reserve Banks should now be in Western cities.

He goes on to explain that there would be too much political turmoil in attempting to relocate a regional Bank and instead proposes expanding the number from 12 to 14 Banks, installing two new locations in populous cities in the Pacific Northwest and the Southwest. While the changing population distribution might be important for additional banks in the West, a simple analysis of the total US population might suggest the need for even more regional Reserve Banks. The current US population is approximately 320 million, a 230% increase from the 1913 drawing of the Federal Reserve map. Compared to a 0% increase in regional Fed Banks, there appears to be a disconnect; to keep the same 8.1 million per Bank proportion, there would need to be about 40 regional Banks. I do not suggest that the 40 number would be correct, as the advent of the television and (more importantly) the Internet has made it significantly easier for economic information to be collected/shared. Possibly the addition of four new regional banks in areas such as New Orleans, Seattle, Los Angeles, and Denver, would help solve the total population and population distribution problems.

Another structural proposal change has to do with the Chair position of the Board of Governors of the Federal Reserve System. Specifically, the current four year term of the Chair leaves this important Fed figure open to political influences. A Washington Post article describes the ever changing relationship between the Chairman and the President:

Many aides in the Reagan administration were frustrated with Paul Volcker's tight money policies, and Volcker took holy hell from home building industries and others stung by high interest rates...The tension between the George H.W. Bush administration and Greenspan was legendary. But the last three presidents—Clinton, George W. Bush, and Obama—have settled into a more agreeable routine with the Fed, in which they do not comment on monetary policy or try to explicitly tell the central bank what to do.

While the past three presidents have taken a more hands-off approach, relying on this goodwill to continue is not an extended long term plan for politically neutral central banking. In addition, as it may take a significant amount of time for monetary policies to take hold in the real economy, the short term periods of the Chair position may result in political pressures removing this individual from power before policies can be carried out. An important structural change to moving the term periods to six or eight years, may go a far way in insulating this decision maker from undue political pressure.