The US’s Federal Reserve System was established more than a century ago as a confederation of 12 regional districts. The selection of cities for each region’s Reserve Bank disproportionately favoured the Northeast and the state of Missouri, a fact that remains controversial to this day. This column describes how the existing banking infrastructure and population density at the time, guided the selection of these cities. Modern communication technology has reduced the need for physical proximity between Reserve and commercial banks. Debates about rezoning the Federal districts should therefore focus on the distribution of monetary policymaking authority.
By Matthew Jaremski and David C. Wheelock*
The Federal Reserve System was established in 1914 as a confederation of 12 regional districts, each with its own Reserve Bank. A Reserve Bank Organisation Committee (RBOC), comprised of the Secretary of the Treasury, Secretary of Agriculture, and Comptroller of the Currency, was appointed to select the cities for Reserve Banks and to set district boundaries. The Reserve Banks remain in the 12 cities selected by the RBOC and, except for a few minor adjustments made early in the system’s history, the borders of the Reserve Districts have never been changed.
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.
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:
- Eastern cities received far more votes from national banks than cities in the West and South; and,
- 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.
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.
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.
Disclaimer: The views in this column are solely those of the authors and should not be interpreted as reflecting the views of the Federal Reserve Bank of St. Louis or of any other person associated with the Federal Reserve System.
*About the authors:
Matthew Jaremski, Assistant Professor of Economics, Colgate University
David C. Wheelock, Vice President and Deputy Director of Research, Federal Reserve Bank of St. Louis
Binder, S and M Spindel (2013) “Monetary politics: Origins of the Federal Reserve”, Studies in American Political Development, 27: 1-13.
Bordo, M D (2015) “Some historical reflections on the governance of the Fed”, presented at a Hoover Institution conference on Central bank governance and oversight reform: A policy conference, May 21.
Comptroller of the Currency (1915) Annual report of the comptroller of the currency, Washington: Government Printing Office.
Fisher, R (2015) “Suggestions after a decade at the Fed”, remarks before the Economic Club of New York, New York City: February 11.
Jaremski, M and D C Wheelock (2015) “Banker preferences, interbank connections, and the enduring structure of the Federal Reserve System”, NBER, WP No. 21553, September.
McAvoy, M (2006) “How were the Federal Reserve Bank locations selected?” Explorations in Economic History, 43: 505-526.
Odell, K A and D F Weiman (1998) “Metropolitan development, regional financial centers, and the founding of the Fed in the Lower South”, The Journal of Economic History, 58: 103-125.
Reserve Bank Organisation Committee (1914) Decision of the Reserve Bank Organisation Committee determining the Federal Reserve Districts and the location of Federal Reserve Banks under the Federal Reserve Act Approved December 23, 1913.
Wheelock, D C (2015) “Economics and politics in selecting Federal Reserve Cities: Why Missouri has two reserve banks”, Federal Reserve Bank of St. Louis Review, 4th Quarter.
Willis, H P (1923) The Federal Reserve System, legislation, organisation and operation, New York: Ronald Press.
1 Odell and Weiman (1998), McAvoy (2006) and Binder and Spindel (2013) also report evidence that the votes strongly influenced selection outcomes.
2 Baltimore is an interesting case. Although national banks had far more correspondent ties to Baltimore than to Richmond, Richmond received more first-choice votes and was selected for the district’s Reserve Bank.