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The enduring structure of the Federal Reserve System: Is it time to redraw the map?

Posted by hkarner - 26. Oktober 2015

Matthew Jaremski, David C. Wheelock 25 October 2015, voxeu

Assistant Professor of Economics, Colgate University

Vice President and Deputy Director of Research, Federal Reserve Bank of St. Louis

The selection of cities for Reserve Banks was controversial in 1914 and remains so today. Seen in Figure 1, the RBOC placed four Reserve Banks within just a few hundred miles of one another in the Northeast, and two Reserve Banks in Missouri; and yet single Reserve Banks serve vast territories in the western two-thirds of the nation. Commentators have long called for a redistribution of Reserve Banks, particularly in light of the shift of US population and economic activity to the South and West that has occurred since 1914 (e.g., Bordo 2015). Richard Shelby (R-AL), chairman of the US Senate Banking Committee, introduced legislation on May 12, 2015 calling for the establishment of an independent commission to review and suggest possible changes to the structure of the Federal Reserve System, including to the number and location of Federal Reserve Banks and district boundaries.

Figure 1. Federal Reserve Districts in 1914

Source: RBOC (1914).

It has long been alleged that political considerations strongly influenced the selection of cities for Reserve Banks (e.g., Willis 1923), though recent scholarship has largely concluded that most of cities chosen for Reserve Banks could be justified on economic grounds (e.g., Binder and Spindel 2013, McAvoy 2006). The Federal Reserve System was established to bring stability to the US banking system, primarily by providing a ready source of liquidity to the commercial banks that joined the Fed System. The Reserve Banks were to be on the front lines, holding the reserves of their member banks, lending to them in emergencies, and operating the payments system. In exchange for purchasing stock in and maintaining a reserve deposit with their local Reserve Bank, members received access to the Fed’s discount window and other services, were paid a dividend, and had a vote in the selection of the Reserve Bank’s board of directors.

Because the Fed’s member banks were both the primary customers and the stockholders of the Reserve Banks, the RBOC gave them a strong voice in choosing where the Reserve Banks were to be located. All national banks (i.e., banks with charters issued by the federal government) were asked to name their top three choices for the location of their Reserve Bank, and those votes appear to have strongly influenced the committee’s decisions. In recent research, we estimate several multivariate regressions of the selection of cities for Reserve Banks and branches, and find that the votes largely explain these selections (Jaremski and Wheelock 2015).1 Further, using voting data aggregated at the county level, we find that the votes go a long way to explaining the boundaries of Federal Reserve districts. Even decisions that today seem questionable, such as the placement of two Reserve Banks in Missouri, seem less so in light of the preferences expressed by national banks at the time (Wheelock 2015).

Our research attempts to explain the votes of national banks for the location of Reserve Banks. Although the votes of individual banks are not available, we find that county-level vote totals are explained well by established correspondent banking relationships. In short, banks appear to have voted for cities where they already had correspondent ties. Cities whose banks already provided services to large numbers of national banks tended to receive more votes, and thus were more likely to be awarded a Reserve Bank or branch office than were other cities.

To a large extent, the Federal Reserve System was placed over the old correspondent banking system it was meant to replace. The major cities in the Northeast—especially New York City, but also Boston, Philadelphia, and Baltimore—had long been important correspondent banking centres. Chicago, St. Louis, Kansas City and Minneapolis were important banking centres in the Midwest, and San Francisco was dominant on the West Coast. All of these cities, save for Baltimore, was given a Reserve Bank.2

More Reserve Banks were placed in the eastern half of the nation than in the west for two reasons:

  1. Eastern cities received far more votes from national banks than cities in the West and South; and,
  2. The Federal Reserve Act stipulated that each Reserve Bank have a minimum capitalisation paid in by its member banks.

Given the sparse population of national banks (and people) in the South and West, shown in Figure 2, Federal Reserve districts in those regions had to be larger than those of the Midwest and Northeast simply to amass enough capital to organise a Reserve Bank. Further, the RBOC may have put more Reserve Banks in the Northeast to reduce the dominance of the banks in New York City, the nation’s financial capital.

Figure 2. National bank locations in 1914

Source: Comptroller of the Currency (1915).

Should there be more Reserve Banks in the West and South?

The question remains whether there should now be more Reserve Banks in the West or South, either by moving some from the Northeast or establishing new districts. The shift of population and economic activity to the West and South since 1914 suggests that were the locations of Reserve Banks and district boundaries set today, the Federal Reserve System map would look very different than the one shown in Figure 1.

The Federal Reserve map has not changed significantly in 100 years, but both the mission and the technology of central banking have changed dramatically. In the early days, when the Fed’s interactions with its member banks were conducted mainly in person or through the mail, minimising transportation times between Reserve Bank offices and member banks was crucial for performing the system’s mission as lender of last resort and for operating the payments system efficiently.

Today most of the interactions between the Reserve Banks and commercial banks are electronic, so close proximity to a Reserve Bank or branch is no longer important for most member banks. Moreover, the Reserve Banks now play a significant role in monetary policymaking—a concept not contemplated by the Fed’s founders.

Concluding remarks

Although the Fed’s decentralised structure arguably promotes good policymaking by helping to ensure that different points of view are heard and different regions of the country are represented, modern communications technology reduces the need for physical proximity to a Reserve Bank.

Probably more important than the physical locations of Reserve Banks is the distribution of monetary policymaking authority on the Federal Open Market Committee (FOMC). Some argue that the Reserve Banks outside of New York should have a stronger voice on the FOMC (e.g., Fisher 2015), while others propose to weaken or even remove altogether the Reserve Banks from monetary policymaking. Those who favour a continued or expanded role for the Reserve Banks contend that the system’s regional diversity and political independence contribute to better policymaking. A system that is responsive to differing economic conditions that might exist across the regions of a large and diverse nation was certainly a principle on which the Federal Reserve was established.

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