The Federal Reserve System’s Regional Structure, Explained

Narrator: In the early part of the 20th century, a series of banking panics in the United States emphasized the need for greater control of our banking system. This ultimately led to the passage of the Federal Reserve Act in 1913.

Wheelock: So, there was a famous meeting of Jekyll Island, Georgia, Nelson Aldrich, a key senator in the Republican Party at that time, and some leading bankers. And they decided what the United States needed was some form of a central bank to provide a way of dealing with these sort of recurring panics that occurred. There was one school of thought, which argued that we want an organization that's, basically, a bank run and controlled for by the major banks, the Wall Street guys. On the other hand, there was a group that said, "No, we need really another government agency to oversee the banking system. It should be politicians or political control, not banker control."

And then there was another aspect of this, which is, "Should we have a central bank, like the Bank of England, which is just in London? Do we want something like that in the U.S., which is either in New York or Washington? Or do we want more of a regional system, where we have banks scattered throughout the country?"

Narrator: The Federal Reserve System that emerged was a political compromise between these public and private concerns. On the private side, a decentralized system of federal banks was created, not unlike private corporations', to meet the individual banking needs of each region.

On the public side is the Board of Governors in Washington, D.C., which provides general oversight of the Fed System and is itself subject to congressional oversight.

Wheelock: The Federal Reserve Act specifies that between eight and 12 Federal Reserve banks will be established throughout the country. The act also created a Reserve bank organizing committee, and this organizing committee went around the country and visited various cities. They studied the regional trading patterns.

You know, St. Louis trades with other cities in Arkansas, and along the Mississippi River, and so forth, where Chicago is more the Upper Midwest. They look at those patterns. They look at where local commercial banks would themselves have correspondent relationships. St. Louis city banks took in deposits from banks in Louisville, Little Rock, and so forth. Not so many from Des Moines, for example. So Des Moines ends up in the Chicago Fed's District, whereas Louisville ends up in the St. Louis Fed's District. So they looked at a variety of economic conditions and trading relationships to decide exactly which cities should be where the Federal Reserve banks are located.

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Narrator: Chief among the Fed's responsibilities, both then and now, was to serve as lender of last resort. That is to increase the supply of money when there are unexpected changes in demand for currency, such as during banking panics. Or when the season demands it, such as during the holiday shopping season, or during planting or harvest time.

Wheelock: There's a tremendous seasonal cycle in economic activity in the United States. So of course, agriculture was particularly important in the 19th century. So money was always tight around harvest time. Interest rates would go up and you'd have shortages and so forth. Well, any other little shock that would come along in the United States or elsewhere, if it came along in October or November, you'd have this already a tight money market. And that could send it into a panic.

And so they located the 12 Reserve banks in different parts of the country, so that they would be responsive to the different credit and currency demands coming from different parts of the country. What's good for Wall Street is not necessarily what's good for Main Street out in St. Louis, or Louisville, or Little Rock.

Narrator: In addition to serving as lender of last resort, does the Fed's regional structure play any role in determining monetary policy?

Wheelock: The Fed's regional structure very much plays a role in determining monetary policy. The St. Louis Fed and all of the reserve banks are very involved in terms of gathering information about economic conditions from throughout their regions, and as well as communicating back the Fed's policies to people within the region.

So an example is the Fed's Beige Book, which is a compilation of anecdotal information about economic conditions on Main Street throughout the country. So we survey automobile dealers. We survey other business people. We survey small manufacturers to ask them how their sales are doing, whether they expect to be hiring more people in the next three to six months.

And then information is consolidated and given to the president of the bank who then presents that information when he goes to Washington to meet with his colleagues on the Federal Open Market Committee. So it's a way of gathering information about economic conditions really ahead of the curve, ahead of the data, which hopefully gives the Fed a little bit of a leg up in terms of making monetary policy.

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Narrator: The Fed's unique public private structure is often described as "independent within government." Meaning the Fed does not need congressional approval for either policymaking or funding, although the Board of Governors oversees the system's budgets.

Likewise, each regional bank has a board of directors made up of local community and business leaders who ensure best practices from the private business world.

Wheelock: The structure of the Fed helps to avoid groupthink. If it was just an agency all located in Washington, all reporting to the same chairperson, it would tend to promote a more of a groupthink mentality. The structure of the Fed with the 12 reserve banks, as well as the Board of Governors in Washington, provides or facilitates a healthy debate by permitting divergence of opinions to be brought forward to the table.

You want to have input that's diverse and varied and reflecting of different schools of thought and economics, different aspects of economic conditions that are arising in different parts of the country. So you want that mix to come in to help form the consensus. The structure of the Fed with the independent or the semi-independent reserve banks promotes a diversity of views, which ultimately help bring about better monetary policymaking.

Narrator: This mixture of public and private accountability isn't without flaws or criticism. And that's OK. Policymaking doesn't occur in a vacuum, and it is often the process of vigorous debate.

Wheelock: Well, it, of course, is a little unwieldy at times. We have 12 Federal Reserve bank presidents and seven board members, and of course, their staffs, economists and others who are out there giving speeches. So sometimes there's not a completely consistent and clear message because some of the debate and uncertainty about policy appears in public.

Now some might find that a bit confusing. But whatever disadvantages there may be are very much outweighed by the advantages of the regional structure in terms of being able to touch base with Main Street and provide the kind of local service, and as well as gathering the input we need from the local communities that I think make for better policymaking.