Fed division of powers: Who controls monetary policy?
As most readers of this blog know, the Federal Reserve is an idiosyncratic mix of public and private. The Board of Governors of the Federal Reserve System is a part of the Federal Government, while the Federal Reserve Banks are private, nonprofit corporations and chartered banks owned by their commercial bank members. The operational capacity of the system – the ability to buy and sell domestic or foreign securities, provide loans to banks or foreign central banks, and engage in repurchase agreements or reverse repurchase agreements – belongs to the Reserve Banks. Then there is the Federal Open Market Committee (FOMC), which sets interest rate and balance sheet policy.
Recent attacks on Federal Reserve independence lead us to ask the following question: Who in the Federal Reserve System controls monetary policy? Put differently, to lower short-term market interest rates as he wishes, what aspect of the Federal Reserve would the President need to control? In this post, we attempt to answer this question.
Before we do, however, we should note that the Federal Reserve has a number of responsibilities other than monetary policy, and nearly all of these belong to the Board of Governors. For example, together with the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and state banking commissions, the Board of Governors regulates and supervises banks. (To the extent that the Reserve Banks engage in supervision, it is under delegated authority from the Board of Governors.) It also is involved in ensuring consumer protection, promoting community development, and fostering an efficient and safe payment system. So, if the President were to take over the Board of Governors, the Administration would control all of these.
But our focus is on monetary policy. There is a large literature on the benefits of giving central banks independence to set their interest rate and balance sheet instruments. Importantly, it is elected officials who both establish the objectives for central banks – generally some combination of price stability, maximum sustainable growth and employment, and financial stability. They also define the tools that central bankers can use to achieve these mandates. It is then up to technocrats with a long horizon to figure out how to achieve these objectives and to ensure transparency sufficient for elected officials to hold them accountable.
There are two primary reasons to grant central banks such instrument independence. First, by extending the policy horizon beyond the next election cycle, independence allows central bankers to deliver lower inflation and a more stable economic and financial system than elected officials, who inevitably face a “time consistency” problem (see our primer). A second reason is that it allows central bankers to resist pressures to finance the government. Were they to succumb, this fiscal dominance also would result in higher inflation.
So, what are the tools that the Federal Reserve uses to achieve its legally mandated objectives, and who in the Federal Reserve System sets those tools?
Here is a list of the interest rate tools:
Federal funds rate target range
Interest rate on overnight repurchase agreement (ON RRP)
Interest rate on standing repurchase agreement facility (SRF)
Discount lending rate
Interest rate on reserve balances (IORB)
Interest rate on the term deposit facility
And here is a list of the balance sheet items (assets, except where noted) that different parts of the Federal Reserve System control:
Treasury and agency securities
Mortgage-backed securities issued by GSEs (e.g. Fannie Mae and Freddie Mac)
Repurchase agreements (repo)
Reverse repurchase agreements (reverse repo, a liability)
Discount loans
Term deposits (a liability)
Loans to foreign central banks
Loans associated with crisis-related facilities
Combined, these components make up what is known as the System Open Market Account (SOMA), which constitutes the consolidated balance sheet of the 12 Reserve Banks (published weekly here). However, only one of the banks – the New York Fed – has the capacity and authority to engage in market operations. That is, the Fed’s purchases and sales, repo and reverse repo, are all executed in New York.
You might think that this complex mix of tools makes it difficult to answer the key question: Who in the Federal Reserve System has the authority to lower the short-term market interest rates that influence economic and financial activity? The answer, however, is straightforward: only the FOMC can achieve this outcome. That is, even though the Board of Governors and the Reserve Banks control specific rates – the interest rate on reserve balances, the discount rate, and the interest rate on term deposits – they cannot lower market interest rates without actions by the FOMC.
To understand this, we take a step back and explain who controls each of the items in the two lists above. Table 1 summarizes the powers of the three groups: the Board of Governors, the Federal Open Market Committee, and the Reserve Banks themselves.
Table 1. Who controls the Fed policy tools?
Source: Authors.
As it turns out, the Reserve Banks control only the rate on discount loans and. subject to commercial bank demand. the amount of discount lending. Neither of these have a material impact on market interest rates outside of a financial crisis. Nevertheless, changes in the discount rate that the Reserve Banks propose require approval by the Board of Governors.
On its own, the Board of Governors can determine two interest rates, the interest on reserves balances (IORB) and the interest rate on the term deposit facility. With the approval of the Secretary of the Treasury, the Board also can create crisis lending facilities (known as 13(3) facilities, after the section of the Federal Reserve Act that authorizes them.
Finally, we come to the Federal Open Market Committee, which controls everything else on the list – all the interest rates and all the balance sheet quantities. That is, they control the target range for the federal funds rate, the ON RRP rate, the SFR rate, and the size and composition of the balance sheet (save for the quantity of discount loans and of crisis lending facilities; see the summary here.)
So why is it that action by the FOMC is necessary to lower market interest rates? The answer is that the FOMC tools allow them to offset any efforts by the Board of Governors or the Banks to lower market interest rates. The FOMC can do so most readily by controlling the rate on overnight reverse repurchase agreements (ON RRP).
To understand the centrality of the FOMC, consider an example based on the following chart. Suppose that the Board of Governors lowers the interest rate on reserve balances (IORB in dashed blue). In theory, banks would then have an incentive to lower lending rates and expand their balance sheet, helping to lower market rates like the four-week Treasury Bill rate (the dashed black line). However, if the FOMC fails to lower the ON RRP rate (the solid red line), then banks will take the balances in their reserve accounts and lend them to the Fed at that attractive ON RRP rate.
The point is that banks will never lend to a customer (or purchase securities) at a rate that is lower than the maximum of the ON RRP and IORB rates. Put differently, either the Board of Governors or the FOMC could independently raise market interest rates, but they must act together to lower them. (Note that if the Reserve Banks and Board of Governors tried to lower the discount rate – the green dotted line – below the ON RRP rate, the latter would still set the floor for bank lending or securities purchases.)
Interest rates: policy and markets (daily), January 2024 – September 2025
Notes: The gap between the IORB and ON RRP rates – currently 15 basis points – mostly reflects the additional cost of FDIC insurance for a commercial bank that receives deposits and places the proceeds at the Fed to receive the IORB. The episodes during which the Treasury Bill rate falls below daily ON RRP rate reflect market expectations of a decline in Federal Reserve policy rates. Source: FRED.
Other interest rates in the table – the SRF rate and the federal funds rate – play a supporting role at best. The standing repo facility (SRF) rate operates like the discount rate, so it is set at a spread over the ON RRP rate. And the target range for the federal funds rate – which is an uncollateralized overnight rate – has waned in importance because transactions are small and banks are no longer the dominant lenders in the federal funds market.
To be sure, when overnight rates are at their effective lower bound – as they were in the financial crisis of 2007-09 and during the pandemic – policymakers use less conventional tools to control market rates. Specifically, they may expand their balance sheet through asset purchases. They also may use forward guidance to communicate their plans for the path of policy interest rates. In both cases, the intent is to lower medium- and long-term market rates where feasible. Since the FOMC controls both the quantity of asset purchases and the central bank’s communication about the path of the ON RRP rate, it is they and not the Board of Governors that set policy at the effective lower bound.
With all of this in mind, the key question for control of monetary policy is: who determines the make-up of the FOMC?
The FOMC is composed of the seven Board Governors and five Reserve Bank Presidents in an annual rotation with the New York Fed a permanent member. So, while all 12 Presidents attend the FOMC meetings, only five vote. This means that when the Board of Governors seats are fully occupied, there are 12 FOMC voters. So, controlling monetary policy requires the votes of seven FOMC members.
President Trump’s recent move to fire Federal Reserve Board Governor Lisa Cook brings into sharp relief the next question: Who can appoint and who can remove Board Governors and Reserve Bank Presidents?
In trying to provide an answer, some things are clear, and some are not. We know that the President nominates Board Governors and that the Senate must confirm them. Currently, the Board of Governors includes two Trump-appointed members (Bowman and Waller), with a third awaiting Senate confirmation (Miran). Should the President succeed in dismissing Governor Cook and if Chair Powell resigns from the Board when his term as Chair expires in May 2026, then President Trump will have the opportunity to name five of the seven.
It also is clear that the Boards of Directors of the Reserve Banks, with the approval of the Board of Governors, appoint the Reserve Bank Presidents. In addition, every five years, the Board of Governors must reapprove all sitting 12 Presidents simultaneously. This reapproval process next occurs in February 2026. In theory, four of seven governors are sufficient to reject the renewal of the 12 sitting Presidents. So, if the President succeeds in replacing Governor Cook before February, it is possible that the four Trump appointees could vote not to renew all the Reserve Bank Presidents early next year.
However, removing the leadership of all the Reserve Banks would almost surely create chaos in the System. Indeed, since the First Vice Presidents of the Reserve Banks are qualified to serve as FOMC members and alternates, a complete takeover of the FOMC may require that the Board of Governors reject their renewal as well (see the FOMC’s rule of organization ).
Regardless of what happens going forward, we already are in uncharted territory. Since its founding in 1914, no Governor or President has been removed. For the case of the Presidents, paragraph f of Section 11 of the Federal Reserve Act reads:
“To suspend or remove any officer or director of any Federal reserve bank, the cause of such removal to be forthwith communicated in writing by the Board of Governors of the Federal Reserve System to the removed officer or director and to said bank.”
This 112-year-old authority is untested. We are not even sure whether the term “cause” in this paragraph means “for cause” in the sense that is traditionally required for firing a federal government official (i.e. malfeasance, neglect, or gross misconduct). Consequently, it will almost surely be up to the courts to decide whether any effort by the Board of Governors to dismiss one or more Reserve Bank Presidents is, in fact, consistent with the Federal Reserve Act.
These administrative questions alone suffice to ensure a period of unprecedented uncertainty ahead. If the Trump administration soon gains a majority on the Board of Governors, there is a plausible path by which they can also gain a majority on the FOMC in short order. However, without control of the FOMC, the Board of Governors alone do not have the ability to lower market interest rates, as President Trump clearly wishes.
Acknowledgment: Without implicating him, we thank Jeremy Kress for helpful guidance.