Download Banking Problems in Emerging Economies

Central Banks, the Fed,
and Monetary Policy
Professor Wayne Carroll
Department of Economics
University of Wisconsin-Eau Claire
[email protected]
Slides available at www.uwec.edu/carrolwd
Central Banks
Bank of Japan
Bank of England
People’s Bank of
China
Federal
Reserve
System
European Central
Bank
Central Banks
Good sources:
 Bank for International Settlements website:
http://www.bis.org/
 Links to central bank websites:
http://www.bis.org/cbanks.htm
The Federal Reserve System
 “The Fed”
 Central bank for the U.S.
 Roles:




Conducts monetary policy (controls the
nation’s money supply)
One of the agencies that regulates the
banking system
“lender of last resort”
Facilitates payments (issues currency, clears
checks)
The Federal Reserve System
The Fed is directed by:
 Board of Governors

7 members appointed by the President and
approved by Congress
 Federal Open Market Committee (FOMC)

12 members, including the Board of
Governors and five other Fed officials
 Chair serves as chairman of both committees
The Federal Reserve System
 Alan Greenspan –
Chair, 1987 - 2006
 Ben Bernanke –
Chair, 2006 - ?
The Federal Reserve System
 The Board of Governors meets in
Washington, D.C.
 The Fed includes 12 regional Federal
Reserve Banks
Some Federal Reserve Banks
New York Fed
Minneapolis Fed
Atlanta
Fed
Some Federal Reserve Banks
The Fed’s Balance Sheet
(billions of dollars, as of December 20, 2006)
Liabilities
Assets
U.S. government securities
Discount loans
Gold and SDR accounts
Other Federal Reserve assets
Total
811.1
0.2
13.2
44.4
Federal Reserve notes
outstanding
Bank deposits (reserves)
U.S. Treasury deposit
Other liabilities
775.9
16.5
5.4
40.7
868.9
Capital
Surplus
Total
30.4
868.9
The Fed and the U.S. Government
The Fed was created to be very independent.
 Not really part of the federal government
 Not directed or controlled by the President,
Congress, or any government agency
 Fed decisions are made by the Board of
Governors and other Fed officials
The President and members of Congress
respect the Fed’s independence.
The Fed and the U.S. Government
Factors that make the Fed more independent:
 Not funded by Congress
 Members of the Board of Governors have long (14year) terms
Factors that make the Fed less independent:
 The Fed was created by Congress, so Congress can
pass legislation that changes the Fed’s structure,
procedures, or policies
 The President appoints members of the Board of
Governors, and they are approved by Congress
Central Bank Independence
 Economists and policy makers believe that
it’s important for a central bank to be
independent from the government.
 Many countries have granted more
independence to their central banks in the
last fifteen years.
Central Bank Independence
Why is an independent central bank better?
 An independent central bank is more likely to
follow low-inflation policies.
 Evidence suggests that in the long run a
central bank can only control the rate of
inflation (not the economic growth rate).
 The government tends to push for policies
that promote faster economic growth in the
short run. If the central bank is independent,
it can say “No.”
Central Bank Independence and Inflation:
Early Evidence
Central Bank Independence and Inflation:
Recent Evidence
Charles T. Carlstrom and Timothy S. Fuerst, “Central Bank Independence: The Key to Price Stability?” Federal Reserve Bank
of Cleveland, September 1, 2006.
Macroeconomic Goals of the Fed
 According to the U.S. Congress, the Fed
should seek “to promote effectively the goals
of maximum employment, stable prices, and
moderate long-term interest rates.”
 These goals are often in conflict.
 The Fed must choose the best balance.
The Fed’s Monetary Policy Tools
 “Monetary policy” refers to changes in the
nation’s money supply brought about by the
Fed.
 “Monetary policy tools” are actions the Fed
can take to alter the money supply.
 Open-Market Operations – the Fed’s
purchases and sales of government bonds for
its own portfolio.
Open-Market Operations
 An open-market purchase causes the nation’s money
supply to increase.
bonds
Public
The Fed
$$$
Open-Market Operations
 Open-market operations take place “on the open market,”
not through transactions with the U.S. Treasury or directly
with banks.
 Controlled by the Federal Open-Market Committee
(FOMC).
 The FOMC meets every six weeks to consider policy
changes.
Federal Funds Rate Target
 The FOMC formulates its monetary policy in terms of a
target level for the federal funds rate.
federal funds rate:
the interest rate banks charge each other
when they borrow and lend reserves.
Federal Funds Rate Target
Banks set the federal funds rate, but the Fed uses openmarket operations to control it.
Open-market purchase:
The Fed buys government bonds.
Sellers of the bonds deposit the funds in banks, so bank
reserves increase.
Banks have more reserves, so they choose to set the
federal funds rate lower.
Similarly, an open-market sale tends to raise the federal
funds rate.
Federal Funds Rate Target
So the Fed sets a target level for the federal funds rate, and
then uses open-market operations to hit the target.
A lower target:
The Fed buys more bonds, and makes the money supply
increase more.
This tends to make the economy grow faster in the short
run.
Therefore the Fed reduces the federal funds rate target in a
recession.
Federal Funds Rate Target
A higher target:
The Fed buys fewer bonds (or sells some of its bonds), so
the money supply increases slowly (or falls).
This tends to slow the economy in the short run.
The Fed uses this policy when it wants to fight inflation.
Federal Funds Rate Since 1990
10%
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
1990
1995
2000
2005
Federal Funds Rate Since 1990
10%
9%
recessions
8%
7%
6%
5%
4%
3%
2%
1%
0%
1990
1995
2000
2005
The Fed’s Monetary Policy
During a recession the Fed:
 Reduces the federal funds target rate
 Makes the money supply grow faster
 Makes the economy grow faster in the short
run
After a recession the Fed:
 Raises the federal funds rate to prevent an
increase in the inflation rate
 Makes the money supply grow more slowly
 Slows the nation’s economic growth in the
short run
Monetary Policy Strategy
 Any central bank’s monetary policy aims at a
nominal anchor target.
 Choices:



Exchange rate
Inflation rate
Money supply
 Targeting a nominal anchor keeps the central
bank focused on low inflation in the long run.
Exchange-Rate Targeting
 The central bank fixes the value of its
currency to the dollar (or some other major
currency).
 The central bank gives up its independent
monetary policy powers.
 Two interesting options:


Currency board (as in Hong Kong)
Dollarization (as in Ecuador)
Inflation Targeting
The central bank:



announces a target range for the inflation rate
(perhaps 1% to 2%)
commits itself to following a monetary policy
that hits the target
Inflation targeting makes it easier for the
central bank to follow a low-inflation policy in
the long run.
The Fed’s Monetary Policy Strategy
 The Fed uses an “implicit nominal anchor” –
an informal long-run inflation target.
 The Fed’s policy has generally been
successful.
 Disadvantages:


Fed officials have a lot of discretion (or power
to choose their policy independently) – too
much?
The Fed’s policies would be more credible and
transparent if the inflation target were formal.
The Fed’s Monetary Policy Strategy
 Ben Bernanke is a
strong advocate of a
more formal inflation
target.
 The Fed might move
slowly toward a
greater reliance on
inflation targeting.