Central Banks and the Federal Reserve System
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Transcript of Central Banks and the Federal Reserve System
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Central Banks and the Federal Reserve System
Chapter 13
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The Price Stability GoalThe Price Stability Goal Low and stable inflationLow and stable inflation
InflationInflationCreates uncertainty and difficulty in planning for Creates uncertainty and difficulty in planning for
the futurethe futureLowers economic growthLowers economic growthStrains social fabricStrains social fabric
Nominal anchor to contain inflation Nominal anchor to contain inflation expectationsexpectations
Time-inconsistency problemTime-inconsistency problem
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Other Goals of Monetary Other Goals of Monetary PolicyPolicy
High employmentHigh employment
Economic growthEconomic growth
Stability of financial marketsStability of financial markets
Interest-rate stabilityInterest-rate stability
Foreign exchange market stabilityForeign exchange market stability
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Should Price Stability be the Should Price Stability be the Primary Goal?Primary Goal?
In the long run there is no conflict between In the long run there is no conflict between the goalsthe goals
In the short run it can conflict with the In the short run it can conflict with the goals of high employment and interest-rate goals of high employment and interest-rate stabilitystability
Hierarchical mandateHierarchical mandate
Dual mandateDual mandate
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Origins of the Federal Origins of the Federal Reserve SystemReserve System
Resistance to establishment of a central Resistance to establishment of a central bankbank
Fear of centralized powerFear of centralized powerDistrust of moneyed interestsDistrust of moneyed interests
No lender of last resortNo lender of last resortNationwide bank panics on a regular basisNationwide bank panics on a regular basisPanic of 1907 so severe that the public was Panic of 1907 so severe that the public was
convinced a central bank was neededconvinced a central bank was needed
Federal Reserve Act of 1913Federal Reserve Act of 1913Elaborate system of checks and balancesElaborate system of checks and balancesDecentralizedDecentralized
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Federal Reserve SystemFederal Reserve System
Source:Source: Federal Reserve Federal Reserve BulletinBulletin..
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Federal Reserve BanksFederal Reserve Banks Quasi-public institution owned by private Quasi-public institution owned by private
commercial banks in the district that are commercial banks in the district that are members of the Fed systemmembers of the Fed system
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Federal Reserve BanksFederal Reserve Banks Member banks elect six directors for each district; three Member banks elect six directors for each district; three
more are appointed by the Board of Governorsmore are appointed by the Board of Governors Three A directors are professional bankersThree A directors are professional bankers Three B directors are prominent leaders from industry, labor, Three B directors are prominent leaders from industry, labor,
agriculture, or consumer sectoragriculture, or consumer sector Three C directors appointed by the Board of Governors Three C directors appointed by the Board of Governors
are not allowed to be officers, employees, or stockholders of are not allowed to be officers, employees, or stockholders of banksbanks
Designed to reflect all constituencies of the publicDesigned to reflect all constituencies of the public
Nine directors appoint the president of the bank subject Nine directors appoint the president of the bank subject to approval by Board of Governorsto approval by Board of Governors
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Policy Tools in the Federal Policy Tools in the Federal Reserve SystemReserve System
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Functions of the Federal Functions of the Federal Reserve BanksReserve Banks
Clear checksClear checks
Issue new currencyIssue new currency
Withdraw damaged currency from circulationWithdraw damaged currency from circulation
Administer and make discount loans to banks in Administer and make discount loans to banks in their districtstheir districts
Evaluate proposed mergers and applications for Evaluate proposed mergers and applications for banks to expand their activitiesbanks to expand their activities
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Functions of the Federal Functions of the Federal Reserve Banks Reserve Banks
Act as liaisons between the business community Act as liaisons between the business community and the Federal Reserve Systemand the Federal Reserve System
Examine bank holding companies and state-Examine bank holding companies and state-chartered member bankschartered member banks
Collect data on local business conditionsCollect data on local business conditions
Use staffs of professional economists to Use staffs of professional economists to research topics related to the conduct of research topics related to the conduct of monetary policymonetary policy
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Member BanksMember Banks All national banks are required to be members of All national banks are required to be members of
the Federal Reserve Systemthe Federal Reserve System
Commercial banks chartered by states are not Commercial banks chartered by states are not required but may choose to be membersrequired but may choose to be members
Depository Institutions Deregulation and Depository Institutions Deregulation and Monetary Control Act of 1980 subjected all Monetary Control Act of 1980 subjected all banks to the same reserve requirements as banks to the same reserve requirements as member banks and gave all banks access to member banks and gave all banks access to Federal Reserve facilitiesFederal Reserve facilities
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Board of Governors of the Board of Governors of the Federal Reserve SystemFederal Reserve System
Seven members headquartered in Seven members headquartered in Washington, D.C.Washington, D.C.
Appointed by the president and confirmed by Appointed by the president and confirmed by the Senatethe Senate
14-year non-renewable term14-year non-renewable term
Required to come from different districtsRequired to come from different districts
Chairman is chosen from the governors and Chairman is chosen from the governors and serves four-year termserves four-year term
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Duties of the Board of Duties of the Board of GovernorsGovernors
Votes on conduct of open market operationsVotes on conduct of open market operations
Sets reserve requirementsSets reserve requirements
Controls the discount rate through “review and Controls the discount rate through “review and determination” processdetermination” process
Sets margin requirementsSets margin requirements
Sets salaries of president and officers of each Sets salaries of president and officers of each Federal Reserve Bank and reviews each bank’s Federal Reserve Bank and reviews each bank’s budgetbudget
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Duties of the Board of Duties of the Board of Governors (cont’d)Governors (cont’d)
Approves bank mergers and applications Approves bank mergers and applications for new activitiesfor new activities
Specifies the permissible activities of bank Specifies the permissible activities of bank holding companies holding companies
Supervises the activities of foreign banks Supervises the activities of foreign banks operating in the U.S.operating in the U.S.
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Chairman of the Board of Chairman of the Board of GovernorsGovernors
Advises the president on economic policyAdvises the president on economic policy
Testifies in CongressTestifies in Congress
Speaks for the Federal Reserve System to Speaks for the Federal Reserve System to the mediathe media
May represent the U.S. in negotiations May represent the U.S. in negotiations with foreign governments on economic with foreign governments on economic mattersmatters
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Federal Open Market Federal Open Market Committee (FOMC)Committee (FOMC)
Meets eight times a yearMeets eight times a year
Consists of seven members of the Board of Consists of seven members of the Board of Governors, the president of the Federal Reserve Governors, the president of the Federal Reserve Bank of New York and the presidents of four Bank of New York and the presidents of four other Federal Reserve banksother Federal Reserve banks
Chairman of the Board of Governors is also Chairman of the Board of Governors is also chair of FOMCchair of FOMC
Issues directives to the trading desk at the Issues directives to the trading desk at the Federal Reserve Bank of New YorkFederal Reserve Bank of New York
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FOMC MeetingFOMC Meeting Report by the manager of system open market Report by the manager of system open market
operations on foreign currency and domestic operations on foreign currency and domestic open market operations and other related issuesopen market operations and other related issues
Presentation of Board’s staff national economic Presentation of Board’s staff national economic forecastforecast
Outline of different scenarios for monetary policy Outline of different scenarios for monetary policy actions actions
Presentation on relevant Congressional actionsPresentation on relevant Congressional actions Public announcement about the outcome of the Public announcement about the outcome of the
meetingmeeting
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Why the Chairman Really Why the Chairman Really Runs the ShowRuns the Show
Spokesperson for the Fed and negotiates Spokesperson for the Fed and negotiates with Congress and the Presidentwith Congress and the President
Sets the agenda for meetingsSets the agenda for meetings
Speaks and votes first about monetary Speaks and votes first about monetary policypolicy
Supervises professional economists Supervises professional economists and advisersand advisers
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How Independent is the Fed?How Independent is the Fed?
Instrument and goal independence. Instrument and goal independence. Independent revenueIndependent revenueFed’s structure is written by Congress, and Fed’s structure is written by Congress, and
is subject to change at any time. is subject to change at any time. Presidential influencePresidential influence
Influence on CongressInfluence on CongressAppoints membersAppoints membersAppoints chairman although terms are not Appoints chairman although terms are not
concurrentconcurrent
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European Central BankEuropean Central Bank
Patterned after the Federal ReservePatterned after the Federal ReserveCentral banks from each country play Central banks from each country play
similar role as Fed bankssimilar role as Fed banksExecutive BoardExecutive Board
President, vice-president and four other President, vice-president and four other members members
Eight year, nonrenewable termsEight year, nonrenewable termsGoverning CouncilGoverning Council
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DifferencesDifferences
National Central Banks control their own National Central Banks control their own budgets and the budget of the ECBbudgets and the budget of the ECB
Monetary operations are not centralizedMonetary operations are not centralized
Does not supervise and regulate financial Does not supervise and regulate financial institutionsinstitutions
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Governing CouncilGoverning Council
Monthly meetings at ECB in Frankfurt, Monthly meetings at ECB in Frankfurt, GermanyGermany
Twelve National Central Bank heads and Twelve National Central Bank heads and six Executive Board memberssix Executive Board members
Operates by consensusOperates by consensus ECB announces the target rate and takes ECB announces the target rate and takes
questions from the mediaquestions from the media To stay at a manageable size as new To stay at a manageable size as new
countries join, the Governing Council will countries join, the Governing Council will be on a system of rotationbe on a system of rotation
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ECB IndependenceECB Independence
Most independent in the worldMost independent in the worldMembers of the Executive Board have long Members of the Executive Board have long
termstermsDetermines own budgetDetermines own budgetLess goal independentLess goal independent
Price stabilityPrice stabilityCharter cannot by changed by legislation; Charter cannot by changed by legislation;
only by revision of the Maastricht Treatyonly by revision of the Maastricht Treaty
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Structure and Independence of Structure and Independence of Other Foreign Central BanksOther Foreign Central Banks
Bank of CanadaBank of CanadaEssentially controls monetary policyEssentially controls monetary policy
Bank of EnglandBank of EnglandHas some instrument independence.Has some instrument independence.
Bank of JapanBank of JapanRecently (1998) gained more independence Recently (1998) gained more independence
The trend toward greater independenceThe trend toward greater independence
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Central Bank BehaviorCentral Bank Behavior
Theory of bureaucratic behavior:Theory of bureaucratic behavior:objective is to maximize its own welfare objective is to maximize its own welfare which is related to power and prestigewhich is related to power and prestigeFight vigorously to preserve autonomyFight vigorously to preserve autonomyAvoid conflict with more powerful groupsAvoid conflict with more powerful groups
Does not rule out altruismDoes not rule out altruism
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Case for IndependenceCase for Independence
Political pressure would impart an Political pressure would impart an inflationary bias to monetary policyinflationary bias to monetary policy
Political business cyclePolitical business cycle
Could be used to facilitate Treasury financing Could be used to facilitate Treasury financing of large budget deficits: accommodationof large budget deficits: accommodation
Too important to leave to politicians—the Too important to leave to politicians—the principal-agent problem is worse for principal-agent problem is worse for politicianspoliticians
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Case Against IndependenceCase Against Independence
UndemocraticUndemocraticUnaccountableUnaccountableDifficult to coordinate fiscal and monetary Difficult to coordinate fiscal and monetary
policypolicyHas not used its independence Has not used its independence
successfullysuccessfully
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