1- Why was the Federal Reserve System set up with 12 regional Federal Reserve banks rather than one central bank, as in other countries?2- Which entities in the Federal Reserve System con- trol the discount rate? Reserve requirements? Open market operations?3- Compare the structure and independence of the Federal Reserve System and the European System of Central Banks.Important Notes:- Use your own words ( No Citation, No References).- Do not write long answers ( 3-5 Sentences ONLY ) for each question.- Find the attached Power point of the chapter ( you may find and use information from it)
chapter_09_powerpoint__1_.pptx
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Chapter 9:
Central Banks and
the Federal
Reserve System
Chapter Preview (1 of 3)
Central banks are the government authorities in change of
monetary policy. For example, in the U.S., the central bank is
the Federal Reserve System. Although we typically hear
about central banks in connection with interest rates, their
actions also affect credit, the money supply, and inflation
(just to name a few areas).
Chapter Preview (2 of 3)
In this chapter, we will more closely examine the structure of
the major central banks throughout the world. We start with
the Fed, looking at both the formal and informal power
structure. We then move to the other central banks.
Chapter Preview (3 of 3)
• We examine the role of government authorities over the money
supply. We focus primarily on the role of the U.S. Federal
Reserve System, but also examine similar organizations in other
nations. Topics include:
– Origins of the Federal Reserve System
– Structure of the Federal Reserve System
– How Independent is the Fed?
– Should the Fed Be Independent?
– Structure and Independence of the European Central Banks
– Structure and Independence of other Foreign Central Banks
Origins of the Federal Reserve System
• Fear of centralized power and distrust of moneyed interests
guided central bank activities in the 19th century.
• The First Bank of the U.S. was disbanded in 1811.
• The Second Bank of the U.S. was disbanded in 1836 when
President Andrew Jackson vetoed its renewal.
• As a result, banking panics became regular events, absent a
lender of last resort, culminating in the panic of 1907.
• Widespread bank failures and depositor losses convinced the
U.S. that a central bank was needed.
Federal Reserve Act of 1913
• Fear of a “central authority” was rampant—people worried
that powerful Wall Street interests would manipulate the
system.
• Questions arose as to whether such a monetary authority
would be private or a government institution.
• The Federal Reserve Act of 1913 was a compromise that
created the Federal Reserve System, including elaborate
checks and balances.
Inside the Fed: The Political Genius of the
Funders of the FRS
• The founders decided against concentrating the federal
banking system in NYC or D.C. in order to maintain public
support for the idea, increasing its effectiveness.
• The 12 branches are spread across the country to make sure
all regions of the country are represented in policy
deliberations.
• The banks are quasi-private institutions, promoting a concern
with regional issues.
Structure of the Federal Reserve System (1 of 2)
• Design was intended to diffuse power along the following
dimensions:
– Regions of the U.S.
– Government and private sector interests
– Needs of bankers, businesses, and the public
• The system as it exists now includes:
–
–
–
–
–
Twelve Federal Reserve Banks
Board of Governors (BOG) of the Federal Reserve System
Federal Open Market Committee (FOMC)
Federal Advisory Council
Member Banks (around 2,000)
Structure of the Federal Reserve System (2 of 2)
The next slide outlines the relationships of these entities to
one another and to the three policy tools of the Fed:
• Open market operations
• Discount rate
• Reserve requirements
Figure 9.1 Structure and Responsibility for
Policy Tools in the Federal Reserve System
Twelve Federal Reserve Banks
• Each of the twelve districts has a main Federal Reserve
Bank and at least one branch office
• The banks are “quasi-public”
– Owned by member commercial banks in the district
– Member banks elect six directors, while three directors
are appointed by the Board of Governors
– Directors represent professional bankers, prominent
business leaders, and public interests (three from
each group)
Structure of the Federal Reserve System
The next slide shows the location of the 12 main Federal
Reserve Banks, and other prominent cities in the Federal
Reserve System.
Figure 9.2 Federal Reserve System
Sources: Federal Reserve Bulletin.
Federal Reserve Bank Functions:
Monetary Policy
• “Establish” the discount rate at which member banks may
borrow from the Federal Reserve Bank (subject to BOG
review)
• Determine which bank receive loans
• Elect one member to the Federal Advisory Council
• Five of the 12 bank presidents vote in the Federal Open
Market Committee
Federal Reserve Bank Functions: General
• Clear checks
• Issue new currency and remove damaged currency
• Administer and make discount loans to banks in their
districts
• Evaluate bank mergers and expansions
• Liaison between local community and the Federal Reserve
System
• Perform bank examinations
• Collect and examine data on local business conditions
• Conduct research related to monetary policy
The FRB of New York (1 of 2)
• The New York Fed is responsible for oversight of some of
the largest financial institutions headquartered in
Manhattan and the surrounding area.
• The New York Fed houses the open market desk. All of the
Feds open market operations (discussed in a bit) are
directed through this trading desk.
The FRB of New York (2 of 2)
• Finally, the chairman of New York Fed is the only
permanent member of the FOMC, serving as the vicechairman of the committee.
• The New York Fed is the only member of the Bank for
International Settlements, providing close contact with
other foreign central bankers
Member Banks (1 of 2)
• National banks (banks chartered by the Office of the
Comptroller of the Currency) are required to be members.
• State commercials banks may elect to join. Currently,
about 1/3 of the commercial banks in the U.S. are
members of the system, down from 49% in 1947.
Member Banks (2 of 2)
Prior to 1980, only member banks were required to maintain
reserves. By 1987, all depository institutions were required
to maintain reserves, eliminating this downside of
membership.
Board of Governors (1 of 2)
• The seven governors are appointed by the President, and
confirmed by the Senate, for 14-year terms on a rotating
schedule.
• All Board members are members of the FOMC.
• Sets reserve requirements and effectively set the discount
rate.
Board of Governors (2 of 2)
• Serve in an advisory capacity to the President of the
United States, and represent the U.S. in foreign economic
matters.
• Other duties as established by legislation (e.g., Regulation
Q, Credit Control Act of 1969).
• Set margin requirements for stock purchases.
• Sets the salary of the president and all officers of each
Federal Reserve bank and reviews each bank’s budget.
Inside the Fed: The research staff (1 of 2)
The Federal Reserve System employs over 500 research
economists. What do all these researchers do?
• Offer insight on incoming economic data and interpret
where it suggests our economy is heading
• Provide briefs for formal meetings on the economic outlook
of the country
Inside the Fed: The research staff (2 of 2)
• Provide support for supervisory staff in decisions about
bank mergers, lending activities, and other technical
advice
• Produce reports on the developments in major foreign
economies
• Public education
Federal Open Market Committee
• Make decisions regarding open market operations, to
influence the monetary base.
• The chairman of the BOG is also the chair of this
committee
• Open market operations are the most important tool that
the Fed has for controlling the money supply (along with
reserve requirements and the discount rate)
• All actions are directed the Federal Reserve Bank of New
York, where securities are bough / sold as required.
Inside the Fed: FOMC Meeting
• Meet eight times each year (about every
six weeks)
• Important agenda items include
– Reports on open market operations (foreign and
domestic)
– National economic forecasts are presented
– Discussion of monetary policy and directives, including
views of each member
– Formal policy directive made
– Post-meeting announcements, as needed
Inside the Fed: The Books
Several research documents are by the Fed, and have been
given official, colorful names:
• Green book: national forecasts for the next two years
• Blue book: projections of monetary aggregates
• Beige book: districts’ “state of the economy”
Chairman of the Federal Reserve System
• Spokesperson for the entire Federal Reserve System, and
supervises the Board’s staff
• Negotiates, as needed, with Congress and the President of
the United States
• With these, the chairman has effective control over the
system, even though he doesn’t have legal authority to
exercise control over the system and its member banks.
Inside the Fed: How Bernanke and Yellen
Differ from Greenspan
Greenspan
vs. Bernanke / Yellen
Professional career running a
consulting firm
Blank
Academics
Disciple of Ayn Rand, believer in
laissez-faire capitalism
Blank
More theorists – involved in model
design/analytics
Not a theorist—believed more in
what the data showed him
Blank
More “informal” and “clear” FOMC
meetings relative to Greenspan
How Independent is the Fed?
• A broad question of policy for the Federal Reserve Systems is
how free the Fed is from presidential and congressional
pressure in pursuing its goals.
• Instrument Independence: the ability of the central bank to set
monetary policy instruments.
• Goal Independence: the ability of the central bank to set the
goals of monetary policy.
• Evidence suggests that the Fed is free along both
dimensions. Further, the 14-year terms (non-renewable) limit
incentives to curry favor with either the President or
Congress.
How Independent is the Fed? Other
Evidence
• The Fed usually generates revenue in excess of its
expenses, so it is not typically under appropriations
pressure.
• However, Congress can enact legislation to gain control of
the Fed, a threat wielded as needed. For example, the
House Concurrent Resolution 133 requires the Fed to
announce its objective growth rate for the money supply.
• Presidential appointment clearly sets the direction of the
Fed.
Should the Fed Be Independent?
• Every few years, the question arises in Congress as to
whether the independence of the Fed should be reduced in
some fashion. This is usually motivated by politicians who
disagree with current Fed policy.
• Arguments can be made both ways, as we outline next
Case for Independence (1 of 3)
The strongest argument for independence is the view that
political pressure will tend to add an inflationary bias to
monetary policy. This stems from short-sighted goals of
politicians. For example, in the short-run, high money growth
does lead to lower interest rates. In the long-run, however,
this also leads to higher inflation.
Case for Independence (2 of 3)
• The notion of the political business cycle stems from the
previous argument.
– Expansionary monetary policy leads to lower
unemployment and lower interest rates—a good idea
just before elections.
– Post-election, this policy leads to higher inflation, and
therefore, higher interest rates—effects that hopefully
disappear (or are forgotten) by the next election.
Case for Independence (3 of 3)
• Other arguments include:
– The Treasury may seek to finance the government
through bonds purchased by the Fed. This may lead to
an inflationary bias.
– Politicians have repeatedly shown an inability to make
hard choices for the good of the economy that may
adversely affect their own well-being.
– Its independence allows the Fed to pursue policies that
are politically unpopular, yet in the best interest of the
public.
Case Against Independence (1 of 2)
• Some view Fed independence as “undemocratic”—an elite
group controlling an important aspect of the economy but
accountable in few ways.
• If this argument seems unfounded, then ask why we don’t
let the other aspects of the country be controlled by an
elite few. Are military issues, for example, any less
complex?
• Indeed, we hold the President and Congress accountable
for the state of the economy, yet they have little control
over one of the most important tools to direct the economy.
Case Against Independence (2 of 2)
• Further, the Fed has not always been successful in the
past. It has made mistakes during the Great Depression
and inflationary periods in the 1960s and 1970s.
• Lastly, the Fed can succumb to political pressure
regardless of any state of independence. This pressure
may be worse with few checks and balances in place.
Explaining Central Bank Behavior
• Two competing theories try to explain the observed
behavior of central banks:
– Public Interest View: the central bank serves the public
interest.
– Theory of Bureaucratic Behavior: the central bank will
seek to maximize its own welfare.
• The Fed often fights to maintain autonomy while avoid
conflict with Congressional power groups. These seem to
favor the latter theory, but this view is probably too extreme
Inside the Fed: The Fed’s Communication
Strategy
The Fed generally likes to keep its actions hidden—not
transparent—to avoid conflicts with Congress and other
politicians. For example, in the past, the Fed didn’t announce
the results of the FOMC meetings. Now it does, but try to
find out what bonds are being traded at the New York Fed –
that is guarded closely.
Inside the Fed: Fed’ s Communication
Strategy (1 of 3)
Has made changes toward more transparency over the
years:
• 1994 – began to reveal the FOMC directives immediately
after each FOMC meeting
• 1999 – began to announce the “bias” toward which
direction monetary policy was likely to go
• 2002 – the Fed started to report the roll call for the FOMC
meeting votes
• 2004 – moved up the release date of the minutes of FOMC
meetings
Inside the Fed: Fed’ s Communication
Strategy (2 of 3)
Each chairman, of course, adds changes to this view:
• In 2007, Bernanke extended the forecast horizon for
FOMC projections from 2 years to 3 years.
• FOMC publishes these projects quarterly (instead of twice
a year).
• The Chairman now also gives a press conference after
FOMC meetings in January, April, June, and November.
• In 2011, provided guidance on target fed funds rates
Inside the Fed: Fed’ s Communication
Strategy (3 of 3)
Each chairman, of course, adds changes to this view:
• In 2011, provided guidance on target fed funds rates.
• In 2012, started adding projections for FOMC forecasts of
the appropriate level of target fed funds rates.
• Anchored inflation target to 2%.
Structure and Independence of the
European Central Bank
• Founded (as it currently exists) in 1999 by a treaty
between the European Central Bank (ECB) and the
European System of Central Banks (ESCB).
• The ECB is housed in Frankfurt, Germany.
• Executive board consists of the president, vice president,
and four members, all serving eight-year terms.
• The policy group consists of the executive board and
governors from the 17 member countries central banks.
The European Central Bank (1 of 4)
Difference between the Fed and the ECB:
• Budgets of the Fed are controlled by the BOG, while the
National banks that make up the ECB control their own
budgets (and the ECBs).
• Monetary operations are conducted at the national level,
not directly by the ECB.
• The ECB is not involved in bank regulation or supervision.
The European Central Bank (2 of 4)
Difference between the Fed and the ECB:
• Only the 17 members attend the monthly meetings of the
ECB, with no staff.
• No voting! All decisions are made by consensus.
• The ECB holds a press conference following the monthly
meeting, while the Fed typically doesn’t.
The European Central Bank (3 of 4)
Difference between the Fed and the ECB:
• Finally, the ECB may actually expand in the future, while
the Fed obviously won’t. Other countries which may
eventually join include the U.K., Sweden, Denmark, and
many others.
The European Central Bank (4 of 4)
• The ECB is the most instrument and goal independent
central bank in the world. It was given independence in the
Maastricht Treaty, and that policy can only be changed by
amending the treaty.
• The treaty set the ECB’s long-term goal as price stability,
so it’s not entirely free to pursue its own goals.
Structure and Independence of Other
Foreign Central Banks
Unlike the United States, central banks of other industrial
countries consist of one central bank that is owned by the
government. Here, we examine the structure and
independence of four important foreign central banks:
• Bank of Canada
• Bank of England
• Bank of Japan
Bank of Canada
• Founded in 1934
• Directors are appointed by the government for three-year
terms, and they appoint a governor for a seven-year term.
• A governing council is the policy-making group comparable
to the FOMC.
• In 1967, ultimate monetary authority was given to the
government. However, this authority has never been
exercised to date.
Bank of England
• Founded in 1694
• The “Court” (like our BOG) consists of the governor, two deputy
governors (five-year terms), and 16 nonexecutive directors
(three-year terms).
• The Monetary Policy committee compares with the U.S. FOMC,
consisting of the governor, deputy governors, two other central
bank officials, plus four outside economic experts.
• The Bank was the least independent of the central banks, until
1997, when it was granted authority to set interest rates.
• The government can step in under “extreme” circumstances, but
has never done so yet.
Bank of Japan (Nippon Ginko) (1 of 2)
• Founded in 1882
• The Policy Board sets monetary policy, and consists of the
governor, two vice governors, and six outside members. All
serve five-year terms.
• The Bank of Japan Law (1998) gave the Bank
considerable instrument and goal independence.
• Japan’s Ministry of Japan can exert authority through its
budgetary approval of the Bank’s non-monetary spending.
Bank of Japan (Nippon Ginko) (2 of 2)
• Recently, Ministry of Finance lost its authority to oversee
many operations of the Bank of Japan.
• In a recent episode, the new Abe government put pressure
on the Bank of Japan to adopt a 2% inflation target against
the wishes of its current Governor.
• Governor resigned! May suggest that the Bank of Japan’s
independence is limited.
Trend toward Independence
In recent years, we have seen a remarkable trend toward
increasing independence. The Fed used to be substantially
more independent than other central banks, but this has
changed with the formation of the ECB and changes at other
central banks. This trend should continue.
Chapter Summary (1 of 3)
• Origins of the Federal Reserve System: A brief history on
central banking in the U.S. was discussed, including key
dates leading to the formation of the Fed.
• Structure of the Federal Reserve System: The checks and
balances of power in the Federal Reserve System were
outlined.
Chapter Summary (2 of 3)
• Structure of the Federal Reserve System: Further, the
internal structure of the Fed and the important
relationships were detailed.
• How Independent is the Fed?: Both the instrument
independence and goal independence of the Federal
Reserve System was discussed.
Chapter Summary (3 of 3)
• Should the Fed Be Independent?: This “big picture”
question was asked and examined from various
perspectives.
• Structure and Independence of the ECB and Other Foreign
Central Banks: The instrument and goal independence of
the foreign counterparts of the Federal Reserve System
was discussed.
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