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"Why Should We Care About the Fed?,"

by Tom Schlesinger May/June 2000 issue of Poverty & Race

As the Federal Reserve steadily continues a series of interest rate hikes it began last June, investors and financial reporters are weighing each pronouncement from the central bank’s marble headquarters as warily as a bomb squad inspecting a mysterious package. But why should ordinary citizens pay attention to the actions of this esoteric institution? Four reasons stand out.

First and foremost, the Fed’s power to adjust interest rates and the money supply wields enormous influence over employment patterns, debt burdens, and the distribution of income and wealth.

• When interest rates remain low and stable, businesses thrive, labor markets tighten and individuals at the bottom of the job ladder find new opportunities for employment, training and workplace leverage. During 1998-1999, this virtuous circle widely benefited have-not and have-some communities as the Fed adopted an expansive monetary policy and unemployment dropped to the lowest sustained levels in two generations.

When the cost of business borrowing goes up, however, employers retrench and workers lose their jobs. Less-skilled, lower-income workers are always the first to feel the pinch during a monetary tightening. According to a Jerome Levy Institute study by economist Willem Thorbecke, minority unemployment increases twice as much as white unemployment in the wake of rising interest rates. If downsizing, underemployment or job insecurity accelerates, workers lose leverage across the board.

The Fed’s last concerted campaign to slow the economy illustrates the point. Despite the absence of inflation, the central bank began a series of seven interest rate hikes in January 1994 that doubled short-term interest rates by early 1995. As a result, economic growth slowed to a snail’s pace — a mere 0.6 percent — by the first quarter of 1995, and remained anemic for most of the year. For 1995 as a whole, the shortfall in national income relative to what would have been generated by a moderate growth rate of 3 percent amounted to $75 billion — $755 for every household in the country. Since each billion dollars of national income translates into 14,000 jobs, restrictive monetary policy probably cost Americans more than a million jobs in 1995.

• Higher interest rates compound household debt burdens and stifle consumer demand by jacking up the cost of mortgage, car, credit card and student loan payments. When household debt expands at high real (inflation-adjusted) interest rates, as it did during the 1990s, income is redistributed from working households to wealthy creditors. The result: greater inequality.

Rate-sensitive households are especially vulnerable.  Based on figures in the Federal Reserve’s recently released Survey of Consumer Finances for 1998, the median household in the $25,000-$50,000 income bracket with mortgage, installment and credit card debt pays nearly $12 per month more for every ¼ percent interest rate increase if it has a variable-rate mortgage, and its consumer loan balances are also susceptible to rate adjustments.  That means $569 per year in additional debt payments for every full percentage point rise in interest rates.

Second, the Fed’s regulatory duties include enforcement of fair lending and community reinvestment statutes, which powerfully influence the availability of credit and the ownership opportunities arising from it. The Fed also has substantial authority – almost all of it unused – to curtail predatory lending practices like usurious interest rates that target poor, working-class and minority communities. Recent legislation (the Gramm-Leach-Bliley Act) that encourages mergers between banks, insurers and securities firms expands the Fed’s direct regulatory reach far beyond the banking industry.

Third, the central bank maintains a little-known but extensive set of community development resources at its Washington headquarters (the Board of Governors) and 12 regional Federal Reserve Banks. This community affairs infrastructure is designed to support local development activities and dwarfs the corresponding divisions at other federal agencies that regulate depository institutions.

Fourth, the Federal Reserve has become the only game in town. As Congress and the Administration developed a bipartisan consensus to ratchet down the role of public spending and investment — and to use budget surpluses to retire Treasury debt — monetary policy has become the preeminent lever of federal influence over the country’s economic direction. More than ever, the central bank effectively determines the governing choices of America’s elected leaders.

In theory, these far-reaching powers equip the central bank to be a powerful engine of widespread prosperity and rising equality — a role it has embraced on some occasions, notably during the New Deal chairmanship of Marriner Eccles. In practice, of course, the Fed has usually embraced a narrower vision of the greater economic good — one defined by the wealth-preservation agenda of bankers and Wall Street.

The Fed’s Unique Structure

Historically, the Fed’s unusual structure and unique status have formed one of the biggest obstacles to people-friendly central banking. Unlike other federal banking agencies, the Fed is not part of the executive branch. And even though it’s a creature of Congress, the central bank remains separate in most respects from the legislative branch as well.

For example, the Fed is the only civilian agency that writes its own budget and completely finances its own operations (mostly through earnings from its portfolio of government securities), without Congressional oversight, authorization or audits. It conducts its most important business behind closed doors due to unique exemptions to the Government in the Sunshine and Freedom of Information Acts.

Moreover, the Fed contains a unique mix of public, private, federal and regional features — including a power-sharing arrangement that gives policymaking authority both to Federal Reserve governors, who are nominated by the President and confirmed by the Senate, and Reserve Bank presidents, who are appointed by regional boards of directors, the majority of whose members are chosen by commercial banking firms.

This structure provides the central bank its famous insulation from partisan politics. But it also enables banks, securities firms, money management companies and other segments of the financial industry to lobby the Fed quietly and continuously out of public view.

Over the years, reformers have persistently tried to increase the Fed’s accountability and democratize its governance through legislation and litigation. But virtually all these attempts — including those led by senior members of Congress and powerful business interests —have failed.

Reform Efforts From Below

Given this history of frustrated reform, it may be time to consider other approaches to changing the Fed. For example, some organizations are attempting to increase the number of Reserve Bank directors who represent labor and community groups (the law expressly provides for representation of these interests along with those of agriculture, commerce and services).

In addition, some of the same organizations have undertaken efforts to boost Reserve Bank accountability to residents in their districts. In 1997, for example, an informal alliance of labor, community and non-profit organizations began an initiative focused on the Federal Reserve Bank of Richmond. The group’s concerns fell into three areas:
• governance — diversifying the interests and perspectives represented on the boards of directors at the Richmond Bank and its branches
• community development — strengthening the Richmond Bank’s role in community-based reinvestment and development activities
• monetary policy — encouraging the Richmond Bank to adopt a more worker- and community-friendly approach to macro-policy by expanding and diversifying its collection of regional economic data and its analysis of the distributional effects of interest-rate policy decisions.

During 1997 and 1998, members of this informal alliance held three meetings with Richmond Fed President Alfred Broaddus, Jr. and other senior staff at the Bank. Participating organizations also sponsored day-long trips for President Broaddus, arranging for him to meet with leaders, staff and members of grassroots groups, union locals and other organizations. Two trips, sponsored by the Virginia Organizing Project, took Broaddus to Virginia’s southside and eastern shore. Another, organized by the South Carolina AFL-CIO, took him on a tour of the Palmetto State. In addition, the informal alliance conducted a briefing for CRA compliance examiners at the Richmond Bank and helped the Bank’s community affairs office conduct workshops in Roanoke and Charlottesville.

As a result of these activities, the Richmond Fed decided to create a Community Development Advisory Council, which held its initial meeting in November 1998. Its members include three leaders from the informal group: South Carolina AFL-CIO President Donna DeWitt; architect Greta Harris, who directs Richmond’s Local Initiatives Support Corporation; and Rep. Gilda Cobb-Hunter, who works at a domestic violence center and is the first African-American since Reconstruction and the first woman ever to lead a party in the South Carolina General Assembly.

A few days of exposure to factory workers and other ordinary citizens in southside Virginia and South Carolina does not appear to have changed President Broaddus’ hard-money world view. But to their credit, Broaddus and the Richmond Bank have not conceived their new advisory group as a perfunctory nod to narrow community development interests. Instead, the Council is designed to incorporate a broad range of previously overlooked perspectives and information into the Bank’s regional economic surveys, research agenda and monetary policy calculus.

Small steps like this won’t turn the Fed on its ear and don’t negate the need for systemic changes in Reserve Bank governance. But persistent, local, move-the-runner-over measures have been a missing ingredient in most previous Fed reform efforts. Without sustained political and intellectual ferment bubbling at the grassroots, even the best-conceived swing-for-the-fences legislation or litigation is unlikely to alter the Fed’s governing structure in the future.

Tom Schlesinger is executive director of the Financial Markets Center, a nonprofit institute that provides research and education resources to citizen groups, labor unions, journalists, policymakers and others interested in the Federal Reserve and the financial sector. Publications are available at no charge by contacting the Financial Markets Center, PO Box 334, Philomont, VA 20131, 540/338-7754. Please specify electronic or surface mail delivery.

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