Download Chapter 16 The Structure of Central Banks: The

Chapter Sixteen
Chapter 16
The Structure of Central Banks: The Federal
Reserve and the European Central Bank
Learning Objectives
1. Structure of the Federal Reserve System.
2. The effectiveness of the Federal Reserve
System.
3. The structure of the Eurosystem.
The Structure of the Federal Reserve System
• Twelve regional Federal Reserve Banks, distributed
throughout the country;
• Board of Governors of the Federal Reserve System,
in Washington, D.C.; and
• The Federal Open Market Committee.
The Structure of the Federal Reserve System
• All national banks are required to belong to the
Federal Reserve System.
• State banks that receive their charters from
individual state banking authorities have the
option of joining, but fewer than 20% do.
The Federal Reserve System:
The Twelve Districts
The Federal Reserve Banks
• Reserve Banks are part public and part private.
• Federally chartered banks and private
• Nonprofit organizations, owned by the
commercial banks in their districts.
The Federal Reserve Banks
• Six directors are elected by the commercial
bank members of the Reserve Bank
– Three directors representing the Reserve Bank and
– Three representing the public.
• The remaining three directors are appointed by
the Boards of Governors.
• Each Reserve Bank has a president who is
appointed for a five-year term by the bank’s
board of directors with the approval of the
Board of Governors.
The Federal Reserve Banks
• The Government’s Bank
– Issues currency,
– Maintains the Treasury’s account, and
– Manages the Treasury debt.
• The Bankers’ Bank
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–
–
–
–
Holds Reserve Deposits,
Operates the Payments System,
Makes Discount Loans at the Discount Rate,
Supervises and regulates financial institutions, and
Collects Data.
The Federal Reserve Banks
• Reserve Banks play an important role in formulating
monetary policy:
• Representation on the Federal Open Market
Committee (FOMC), and
• Through their participation in setting the discount
rate.
• The New York Fed:
• Executes Open market Operations.
• Runs Fedwire: Interbank Funds Transfer System
The Board of Governors
• The seven members, appointed by the
president and confirmed by the U.S. Senate for
14-year terms.
• The long terms are intended to foster
independence by protecting the board from
political pressure.
• The terms are staggered limiting any individual
president's influence over the membership.
The Board of Governors
• Duties of the governors are to:
– Set the reserve requirement,
– Approve or disapprove discount rate
recommendations,
– Rule-writing agency for consumer credit
protection laws
• (with enforcement by the Consumer Financial Protection
Bureau created by the Dodd-Frank Act),
The Board of Governors
• Duties of the governors (cont.)
– Along with the Reserve Banks, regulate and
supervise the banking system,
– Invoke the emergency powers to lend to nonbanks
(powers were curtailed by the Dodd-Frank Act),
– Analyze financial and economic conditions, and
– Collect and publish detailed statistics.
The Federal Open Market Committee
• When the press discusses the Fed, its the Federal
Open Market Committee (FOMC).
– sets the interest rates and adjusts the Fed’s balance
sheet to control the availability of money and credit to
the economy.
• It has existed since 1936 and has 12 voting
members:
– The seven governors,
– The president of the Federal Reserve Bank of New
York, and
– A rotating selection of 4 of the remaining 11 Reserve
Bank presidents.
The Federal Open Market Committee
• The chair of the Board of Governors chairs
the FOMC.
• The committee’s vice chair is the president
of the Federal Reserve Bank of New York.
• While only 5 of the 12 Reserve Bank
presidents vote at any one time, all of them
participate in the meeting.
The Federal Open Market Committee
• Controls the federal funds rate.
– This is the rate banks charge each other for
unsecured overnight loans on their excess
deposits at the Fed.
• Intent - by controlling the federal funds rate,
the FOMC influences real growth.
The Federal Open Market Committee
• The FOMC currently meets 8 times a year.
– Committee can confer and change policy over
the telephone.
– The financial crisis of 2007-2009 prompted 12
unscheduled FOMC meetings.
• The primary purpose of a meeting is to
decide on the target interest rate.
• Gives directive to the system open market
account manager who works for the Federal
Reserve Bank of New York to carry out OMO.
The Federal Open Market Committee
Where does the committee’s power lie and who
controls interest-rate decisions?
1. The chair is the voice of the Fed.
2. The governors make up a majority of the
committee.
3. The chair sets the agenda for FOMC meetings,
determines the order in which people speak, and
proposes the FOMC policy statement.
4. Board of Governors controls the Reserve Banks’
budgets and salaries of their presidents.
Assessing the Federal Reserve System’s Structure
• Previous chapter, an effective central bank is
one in which:
– Policymakers are independent of political
influence,
– Make decisions by committee,
– Are accountable and transparent, and
– State their objective(s) clearly.
• Evaluate the Fed using these criteria.
Independence from Political Influence
• There are three criteria for judging central bank
independence:
– Budgetary independence,
– Irreversible decisions, and
– Long terms in office.
• The Fed meets each of these.
Independence from Political Influence
• The Fed controls its own budget.
– substantial revenue comes from interest on
government securities it holds and fees charged
to banks for payments system services.
– typically 95% of its income is returned to the
U.S. Treasury each year.
• Interest rate changes are implemented
immediately and can be changed only by the
FOMC.
• The terms of the governors are 14 years,
chair’s term is 4 years, and Reserve Bank
presidents serve for 5 years.
Financially Independent
• In 2015,
• Earned about $113 Billion on securities.
• Less interest on reserves and other expenses
of $13 Billion,
• Turned $100 Billion over to Treasury.
Decision Making by Committee
• The Fed clearly makes decision by committee the FOMC
• While the chair of the Board of Governors may
dominate policy decision, the fact that there are
12 voting member provides an important
safeguard against arbitrary action.
Accountability and Transparency
• The FOMC releases huge amount of information to
the public:
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–
–
–
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Announcement of policy decision and reasoning,
Detailed minutes of the meeting 3 weeks later,
Word-for-word transcript 5 years later,
Twice-yearly “Monetary Policy Report to the Congress”,
The chair’s appearance before Congress to discuss the state
of the nation’s economy, and
– Numerous speeches given by the chair, other governors and
Reserve Bank presidents.
Two events provide the foundation for Fed independence:
1. In 1935, political appointees were removed from the Federal
Reserve Board, and the FOMC was created.
2. In 1951, President Truman supported the Fed’s refusal to
purchase Treasury securities that the Secretary of the
Treasury requested they buy.
• The president, the secretary of the Treasury, and the
Federal Reserve chair reached an “accord” and issued a
joint announcement establishing the FOMC’s independence
in setting interest rates and controlling the rate of monetary
expansion.
Fed’s Policy Framework
The Congress has set the Fed’s objectives:
“The Board of Governors of the Federal Reserve System and the
Federal Open Market Committee shall maintain long run
growth of the monetary and credit aggregates commensurate
with the economy’s long run potential to increase production,
so as to promote effectively the goals of maximum
employment, stable prices, and moderate long-term interest
rates.”
European Central Bank(ECB)
• European Monetary Union began
January 1, 1999
• Euro notes and coins began circulation
January 1, 2002
• 19 of 28 countries in the European Union use
the Euro
http://www.ecb.europa.eu/euro/intr
o/html/map.en.html
The European Central Bank
• The agreement to form a European monetary
union was formalized in the Treaty of Maastricht.
• The ECB and the NCBs of the 19 countries that
participate in the monetary union make up what
is known as the Eurosystem.
– They share a common currency and common
monetary policy.
• European Central Bank (ECB) is the institution
that is responsible for monetary policy in the
euro area.
Organizational Structure
• The ECB mirrors the structure of the Federal
Reserve System in several ways.
– A six-member Executive Board of the ECB, similar to
the Board of Governors;
– The National Central Banks play many of the same
roles as the Federal Reserve Banks; and
– The Governing Council formulates monetary policy as
the FOMC does.
Organizational Structure
• The Executive Board has a president and a vice
president who play the same role as the Fed’s
Board of Governors.
• ECB executive board members are appointed by
a committee composed of the heads of state of
the countries that participate in the monetary
union.
Organizational Structure
• The ECB and the NCBs together perform the
traditional operational functions of a central
bank.
– They use interest rates to control the availability
of money and credit in the economy, and
– They are responsible for the smooth operation
of the payments system and the issuance of
currency.
• The National Central Banks continue to serve
as bankers to the banks and governments in
their countries.
Organizational Structure
• Monetary policy
• The Governing Council is composed of the six
Executive Board members and the governors
of 15 of the 19 central banks in the euro area.
• Meetings are held monthly to determine
policy
Organizational Structure
• The Governing Council members are charged with
setting policy for the euro area as a whole,
regardless of economic conditions in the
individual countries.
– The decisions are made for the benefit of the euro
area, not for individual countries.
• Decisions are made by formal votes of the
Council, but are not published.
– Ensure that Governing Council members focus on
setting policy for the euro area as a whole
Organizational Structure
Important safeguards were included in the Treaty of
Maastricht to ensure the central bank’s
independence.
1. There are terms of office (8 year term).
2. The treaty states explicitly that the Governing Council
cannot take instructions from any government, so its
policy decisions are irreversible.
The Price Stability Objective and Monetary
Policy Strategy
The Treaty of Maastricht states:
“The primary objective of the European System of
Central Banks shall be to maintain price stability.
Without prejudice to the objective of price
stability, the ESCB shall support the general
economic policies in the Community.”
• This includes the objective of sustainable and
non-inflationary growth.
The Price Stability Objective and Monetary Policy Strategy
• The Treaty is widely understood to place
priority on price stability as the top objective
for the ECB.
• The ECB’s Governing Council defines price
stability as an inflation rate of close to 2
percent, based on a euro-area-wide measure
of consumer prices.
– This is the harmonized index of consumer prices
(HICP) and is similar to the CPI.
– It is the average of retail price inflation in all the
countries of the monetary union, weighted by the
size of their gross domestic products.
The Price Stability Objective and Monetary
Policy Strategy
• This arrangement has important implications for
monetary policy, because there will be times
when the proper policy for a small country is to
raise interest rates but the proper policy for
Germany is to lower them.
– Given relative size, a change in inflation or growth in
a small country has little impact on the euro area as
whole.
The Price Stability Objective and Monetary
Policy Strategy
• The fact that the economically large countries
matter much more than the small ones can affect
the dynamics of the governing council’s interest
rate decisions.
• The governing Council’s job is to stabilize prices
in the euro area as a whole
– one wonders whether activities in the smaller
countries might have undue influence on its policy
decisions.
The Price Stability Objective and Monetary
Policy Strategy
• Evidence strongly suggests that the ECB is
doing the job it is supposed to do.
• The Governing council’s policy has been
appropriate to the euro area.
– It has not been skewed toward smaller countries’
concerns.
• The specificity of the price stability objective
holds policymakers accountable.
– It limits discretion in their decision making.
ECB Independence
• Most independent in the world
• Members of the Executive Board have long
terms (8 years)
• Determines own budget
• Less goal independent compared to the Fed

Price stability
• Charter cannot by changed by legislation; only
by revision of the Maastricht Treaty
http://www.ecb.int/ecb/orga/indepe
ndence/html/index.en.html
Bank of Canada
•
•
•
•
•
1934
Inflation target since 1991
Target range 1- 3 percent
Monetary Policy aimed at mid-point: 2%
Less goal independence than Fed

http://www.bankofcanada.ca/en/monetary/in
flation_target.html (Follow this link and read
the BOC statement)
Bank of England
• 1694
• Least independent up to 1997. Interest rate
policy determined by chancellor of the
Exchequer.
• Policy now with the Bank, but can be
overridden by the government.
• Inflation target – 2 percent.
• http://www.bankofengland.co.uk/Pages/home.
aspx