Getting to Know the Nation's Central Bank

Crisis, The, Jul/Aug 2006 by Spriggs, William E

In April, Roger W. Ferguson stepped down as vice chairman of the Federal Reserve Board of Governors. Ferguson, who holds a Ph.D. in economics from Harvard, was originally appointed by President Bill Clinton in 1997 to fill a term expiring in 2000, and then was reappointed by President George W. Bush. He was the first African American to serve as vice chairman of the Federal Reserve, and his term in the position from 1999 to 2006 is the longest tenure as vice chairman in more than 30 years.

When Ferguson stepped down, he was arguably the second most powerful African American in Washington, next to secretary of State Condoleezza Rice. What is it about the Federal Reserve that made Ferguson so powerful?

Earlier in the year, when Alan Greenspan (who was appointed in August 1987) stepped down as chairman of the Federal Reserve Board of Governors, he was given plenty of platitudes by the press. Business reporters give him high marks for steering the economy through Black Monday (Oct. 19, 1987) and the expansion of the 1990s that generated low unemployment and high economic growth rates with low inflation.

While Greenspan was chairman of the Fed, African Americans benefited from the 1990s economic expansion that reduced Black unemployment and family poverty rates to record lows. But Greenspan was also chairman of the Fed when average Black family incomes fell between 1990 and 1992, and between 2002 and 2005, and Black family poverty rates rose from 27.8 percent in 1989 to 31.3 percent in 1993, the highest rates since the 1960s.

What does the Federal Reserve do that could influence these outcomes, which occur over a shorter period than could be explained by changes in education or training or marriage rates? And why if being on the Fed is such a powerful position are the appointees largely ignored by the civil rights mainstream and by African Americans in general?

The Federal Reserve was created by an act of Congress in 1913. After several failed attempts at central banks and reserve bank systems, this act stabilized the national banking system. Essentially, the Fed is the bank to America's commercial banking sector. In that role, it determines the amount of credit available in the economy and interest rates - the cost of getting money. Therefore, the actions of the Fed indirectly determine how much your home mortgage rate will be, how much it will cost to borrow money to buy a car, or how much it will cost a business to borrow to buy a new machine or expand its office space. And because, as the saying goes, "it takes money to make money," that means the Fed is central to whether the economy expands or contracts; whether businesses are hiring or firing.

The president nominates, and the Senate confirms, members of the Federal Reserve Board of Governors to 14-year terms, or to complete terms when there are vacancies. There are seven members of the Board.

(While Ferguson was the first African American to serve as vice chair of the board, two others have served as members. He was preceded by Andrew Brimmer, also a Harvard Ph.D. in economics, who was appointed by President Lyndon B. Johnson and served from 1966 to 1974; and by Emmett Rice, who earned his Ph.D. in economics from the University of California at Berkeley and was appointed by President Jimmy Carter, serving from 1979 to 1986.)

While it is possible that a president would never get to nominate a governor because their 14year terms are longer than the eight-year maximum a president may serve, in practice, as a result of early departures, most presidents have had the chance to appoint all seven members of the board. Congress plays an oversight role through biannual presentations the chairman of the Fed is required to make before both the House and Senate banking committees.

Understanding that the role of the Fed is so powerful, Congress gave guidance to Fed policy with the passage of the Humphrey-Hawkins Act of 1978. Initially offered by Rep. Augustus Hawkins (D-Calif.), the first Black elected to Congress from a Western state, the aim was to renew the push for a full-employment policy by the federal government. The effort barkened back to the 1963 push for "Jobs and Justice" and the role that A. Philip Randolph played in centering the Civil Rights Movement on economics.

But, while the Humphrey-Hawkins Act urges the Fed to try and maintain the economy at full employment, it also gives weight to a policy of "stable prices." The latter point comes from a belief by many economists that falling unemployment levels will push up wage demands from workers, which will push up costs to businesses, resulting in higher prices for goods bought by workers, and the start of a spiral of demands for higher wages to cover the now higher prices, and so on. In practical terms, it means that the Act has caused a retreat from full-employment as a protection against inflation.

Many economists would argue that the Fed does not have the tools to control both prices and output. So, it must make a tradeoff in setting its policy. Additionally, the Fed needs to worry about the effects of its policy on many things. In the late 1990s, the Fed was concerned that the stock market was overheated, as in the late 1980s many were concerned with an overheated office building boom. Today some economists are worried that Greenspan did not pay enough attention to the growing trade deficit the U.S. has with the rest of the world, called the current account deficit. America's mounting debt to the world will put pressure on the economy in the future because it increases the claims that foreigners have on future U.S. income.