Chapter13CentralBanksandtheFederalReserveSystemCentralBanksBankofJapanBankofEnglandEuropeanCentralBankPeople’sBankofChinaFederalReserveSystemThePriceStabilityGoalLowandstableinflationInflationCreatesuncertaintyanddifficultyinplanningforthefutureLowerseconomicgrowthStrainssocialfabricNominalanchortocontaininflationexpectationsTime-inconsistencyproblemOtherGoalsofMonetaryPolicyHighemploymentEconomicgrowthStabilityoffinancialmarketsInterest-ratestabilityForeignexchangemarketstabilityShouldPriceStabilitybethePrimaryGoal?InthelongrunthereisnoconflictbetweenthegoalsIntheshortrunitcanconflictwiththegoalsofhighemploymentandinterest-ratestabilityHierarchicalmandateDualmandateOriginsoftheFederalReserveSystemResistancetoestablishmentofacentralbankFearofcentralizedpowerDistrustofmoneyedinterestsNolenderoflastresortNationwidebankpanicsonaregularbasisPanicof1907soseverethatthepublicwasconvincedacentralbankwasneededFederalReserveActof1913ElaboratesystemofchecksandbalancesDecentralizedStructureoftheFederalReserveSystemDesignwasintendedtodiffusepoweralongthefollowingdimensions:RegionsoftheU.S.GovernmentandprivatesectorinterestsNeedsofbankers,businesses,andthepublicThesystemasitexistsnowincludes:TwelveFederalReserveBanksBoardofGovernors(BOG)oftheFederalReserveSystemFederalOpenMarketCommittee(FOMC)FederalAdvisoryCouncilMemberBanks(around2,800)FIGURE1StructureandResponsibilityforPolicyToolsintheFederalReserveSystemFIGURE2FederalReserveSystemSource:FederalReserveBulletin.FederalReserveBanksQuasi-publicinstitutionownedbyprivatecommercialbanksinthedistrictthataremembersoftheFedsystemMemberbankselectsixdirectorsforeachdistrict;threemoreareappointedbytheBoardofGovernorsThreeAdirectorsareprofessionalbankersThreeBdirectorsareprominentleadersfromindustry,labor,agriculture,orconsumersectorThreeCdirectorsappointedbytheBoardofGovernors

arenotallowedtobeofficers,employees,orstockholders

ofbanksFederalReserveBanks(cont’d)Memberbankselectsixdirectorsforeachdistrict;threemoreareappointedbytheBoardofGovernors(cont’d)DesignedtoreflectallconstituenciesofthepublicNinedirectorsappointthepresidentofthebanksubjecttoapprovalbyBoardofGovernorsFunctionsoftheFederalReserveBanksClearchecksIssuenewcurrencyWithdrawdamagedcurrencyfromcirculationAdministerandmakediscountloanstobanksintheirdistrictsEvaluateproposedmergersandapplicationsforbankstoexpandtheiractivitiesFunctionsoftheFederalReserveBanks(cont’d)ActasliaisonsbetweenthebusinesscommunityandtheFederalReserveSystemExaminebankholdingcompaniesandstate-charteredmemberbanksCollectdataonlocalbusinessconditionsUsestaffsofprofessionaleconomiststoresearchtopicsrelatedtotheconductofmonetarypolicyFederalReserveBanksandMonetaryPolicyDirectors“establish”thediscountrateDecidewhichbankscanobtaindiscountloansDirectorsselectonecommercialbankerfromeachdistricttoserveontheFederalAdvisoryCouncilwhichconsultswiththeBoardofGovernorsandprovidesinformationtohelpconductmonetarypolicyFiveofthe12bankpresidentshaveavoteintheFederalOpenMarketCommittee(FOMC)TheFRBofNewYorkBeforewediscussthememberbanksofthesystem,it’sworthtalkingaboutthespecialrolethattheNewYorkbankplaysinthesystem.BeinginNYC,theNewYorkFedisresponsibleforoversightofsomeofthelargestfinancialinstitutionsheadquarteredinManhattanandthesurroundingarea.TheFRBofNewYorkTheNewYorkFedhousestheopenmarketdesk.AlloftheFedsopenmarketoperations(discussedinabit)aredirectedthroughthistradingdesk.TheNewYorkFedistheonlymemberoftheBankforInternationalSettlements,providingclosecontactwithotherforeigncentralbankers.TheFRBofNewYorkFinally,thechairmanofNewYorkFedistheonlypermanentmemberoftheFOMC,servingasthevice-chairmanofthecommittee.MemberBanksAllnationalbanksarerequiredtobemembersoftheFederalReserveSystemCommercialbankscharteredbystatesarenotrequiredbutmaychoosetobemembersDepositoryInstitutionsDeregulationandMonetaryControlActof1980subjectedallbankstothesamereserverequirementsasmemberbanksandgaveallbanksaccesstoFederalReservefacilitiesBoardofGovernorsoftheFederalReserveSystemSevenmembersheadquarteredinWashington,D.C.AppointedbythepresidentandconfirmedbytheSenate14-yearnon-renewabletermRequiredtocomefromdifferentdistrictsChairmanischosenfromthegovernorsandservesfour-yeartermDutiesoftheBoardofGovernorsVotesonconductofopenmarketoperationsSetsreserverequirementsControlsthediscountratethrough“reviewanddetermination”processSetsmarginrequirementsSetssalariesofpresidentandofficersofeachFederalReserveBankandreviewseachbank’sbudgetDutiesoftheBoardofGovernors(cont’d)ApprovesbankmergersandapplicationsfornewactivitiesSpecifiesthepermissibleactivitiesofbankholdingcompaniesSupervisestheactivitiesofforeignbanksoperatingintheU.S.ChairmanoftheBoardofGovernorsAdvisesthepresidentoneconomicpolicyTestifiesinCongressSpeaksfortheFederalReserveSystemtothemediaMayrepresenttheU.S.innegotiationswithforeigngovernmentsoneconomicmattersAlanGreenspan–Chair,1987-2006BenBernanke– Chair,2006-?HowBernanke’sStyleDiffersfromGreenspan’sGreenspanvs.BernankeProfessionalcareerrunningaconsultingfirmAcademiccareeratStanfordandPrincetonDiscipleofAynRand,believerinlaissez-fairecapitalismMoreofatheorists—involvedinmodeldesignNotatheorist—believedmoreinwhatthedatashowedhimMore“informal”FOMCmeetingsrelativetoGreenspanFederalOpenMarketCommittee(FOMC)MeetseighttimesayearConsistsofsevenmembersoftheBoardofGovernors,thepresidentoftheFederalReserveBankofNewYorkandthepresidentsoffourotherFederalReservebanksChairmanoftheBoardofGovernorsisalsochairofFOMCIssuesdirectivestothetradingdeskattheFederalReserveBankofNewYorkTheFederalReserveSystemTheBoardofGovernorsmeetsinWashington,D.C.TheFedincludes12regionalFederalReserveBanksFOMCMeetingReportbythemanagerofsystemopenmarketoperationsonforeigncurrencyanddomesticopenmarketoperationsandotherrelatedissuesPresentationofBoard’sstaffnationaleconomicforecastOutlineofdifferentscenariosformonetarypolicyactionsPresentationonrelevantCongressionalactionsPublicannouncementabouttheoutcomeofthemeetingWhytheChairmanReallyRunstheShowSpokespersonfortheFedandnegotiateswithCongressandthePresidentSetstheagendaformeetingsSpeaksandvotesfirstaboutmonetarypolicySupervisesprofessionaleconomists

andadvisersHowIndependentistheFed?Instrumentandgoalindependence.IndependentrevenueFed’sstructureiswrittenbyCongress,andissubjecttochangeatanytime.PresidentialinfluenceInfluenceonCongressAppointsmembersAppointschairmanalthoughtermsarenotconcurrentEuropeanCentralBankPatternedaftertheFederalReserveCentralbanksfromeachcountryplaysimilarroleasFedbanksExecutiveBoardPresident,vice-presidentandfourothermembersEightyear,nonrenewabletermsGoverningCouncilDifferencesNationalCentralBankscontroltheirownbudgetsandthebudgetoftheECBMonetaryoperationsarenotcentralizedDoesnotsuperviseandregulatefinancialinstitutionsGoverningCouncilMonthlymeetingsatECBinFrankfurt,GermanyTwelveNationalCentralBankheadsand

sixExecutiveBoardmembersOperatesbyconsensusECBannouncesthetargetrateandtakesquestionsfromthemediaTostayatamanageablesizeasnewcountriesjoin,theGoverningCouncilwill

beonasystemofrotationECBIndependenceMostindependentintheworldMembersoftheExecutiveBoardhavelongtermsDeterminesownbudgetLessgoalindependentPricestabilityChartercannotbychangedbylegislation;onlybyrevisionoftheMaastrichtTreatyStructureandIndependenceofOtherForeignCentralBanksBankofCanadaEssentiallycontrolsmonetarypolicyBankofEnglandHassomeinstrumentindependence.BankofJapanRecently(1998)gainedmoreindependenceThetrendtowardgreaterindependenceBankofCanadaFoundedin1934Directorsareappointedbythegovernmentforthree-yearterms,andtheyappointagovernorforaseven-yearterm.Agoverningcouncilisthepolicy-makinggroupcomparabletotheFOMC.In1967,ultimatemonetaryauthoritywasgiventothegovernment.However,thisauthorityhasneverbeenexercisedtodate.BankofEnglandFoundedin1694The“Court”(likeourBOG)consistsofthegovernor,twodeputygovernors(five-yearterms),and16nonexecutivedirectors(three-yearterms).TheMonetaryPolicycommitteecompareswiththeU.S.FOMC,consistingofthegovernor,deputygovernors,twoothercentralbankofficials,plusfouroutsideeconomicexperts.TheBankwastheleastindependentofthecentralbanks,until1997,whenitwasgrantedauthoritytosetinterestrates.Thegovernmentcanstepinunder“extreme”circumstances,buthasneverdonesoyet.BankofJapan(NipponGinko)Foundedin1882ThePolicyBoardsetsmonetarypolicy,andconsistsofthegovernor,twovicegovernors,andsixoutsidemembers.Allservefive-yearterms.TheBankofJapanLaw(1998)gavetheBankconsiderableinstrumentandgoalindependence.Japan’sMinistryofJapancanexertauthoritythroughitsbudgetaryapprovaloftheBank’snon-monetaryspending.TrendtowardIndependenceInrecentyears,wehaveseenaremarkabletrendtowardincreasingindependence.TheFedusedtobesubstantiallymoreindependentthanothercentralbanks,butthishaschangedwiththeformationoftheECBandchangesatothercentralbanks.Thistrendshouldcontinue.CentralBankBehaviorTheoryofbureaucraticbehavior:

objectiveistomaximizeitsownwelfarewhichisrelatedtopowerandprestigeFightvigorouslytopreserveautonomyAvoidconflictwithmorepowerfulgroupsDoesnotruleoutaltruismCaseforIndependencePoliticalpressurewouldimpartaninflationarybiastomonetarypolicyPoliti