Central Banks: A Global Perspective

Chapter 9

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Chapter PreviewCentral banks are the government authorities in change of monetary policy. For example, in the U.S., the central bank is the Federal Reserve System and in Europe it is the European Central Bank. 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 PreviewIn 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.

Origins of the Federal Reserve SystemResistance to establishment of a central bankFear of centralized powerDistrust of moneyed interestsNo lender of last resortNationwide bank panics on a regular basisPanic of 1907 so severe that the public was convinced a central bank was neededFederal Reserve Act of 1913Elaborate system of checks and balancesDecentralized

Structure of The Federal Reserve SystemThe writers of the Federal Reserve Act wanted to diffuse power along regional linesFederal Reserve System include the following entitiesThe 12 Federal Reserve banksThe Board of Governors of the Federal Reserve SystemThe Federal Open Market Committee (FOMC)The Federal Advisory CouncilAround 2,900 member commercial banks

FIGURE 9.1 Federal Reserve SystemSource: Federal Reserve Bulletin.

Federal Reserve BanksQuasi-public institution owned by private commercial banks in the district that are members of the Fed systemMember banks elect six directors for each district; three more are appointed by the Board of GovernorsTogether, these nine directors appoint the president of the bank subject to approval by Board of Governors

Functions of the Federal Reserve BanksClear checksIssue new currencyWithdraw damaged currency from circulationAdminister and make discount loans to banks in their districtsEvaluate proposed mergers and applications for banks to expand their activities

Member BanksAll national banks are required to be members of the Federal Reserve SystemCommercial banks chartered by states are not required but may choose to be membersDepository Institutions Deregulation and Monetary Control Act of 1980 subjected all banks to the same reserve requirements as member banks and gave all banks access to Federal Reserve facilities

Board of Governors of the Federal Reserve SystemSeven members headquartered in Washington, D.C.Appointed by the president and confirmed by the Senate14-year non-renewable termRequired to come from different districtsChairman is chosen from the governors and serves four-year term

Federal Open Market Committee (FOMC)Meets eight times a yearConsists of seven members of the Board of Governors, the president of the Federal Reserve Bank of New York and the presidents of four other Federal Reserve banksThe chairman of the Board of Governors is also chair of FOMCIssues directives to the trading desk at the Federal Reserve Bank of New York

How Independent is the Fed?Instrument and goal independence. Independent revenueFeds structure is written by Congress, and is subject to change at any time. Presidential influenceInfluence on CongressAppoints membersAppoints chairman although terms are not concurrent

Structure and Independence of The European Central BankThe ESCB encompasses the ECB and the National Central Banks of the 27 EU member states The Eurosystem comprises of the ECB and the NCBs of only the sixteen countries that have adopted the euroThe decision-making process at the EMU takes place at three levelsThe Governing Council, the Executive Board and the General Council

Governing Council Executive Board and General CouncilGoverning CouncilThe supreme decision-making body of the ECB, comprises the six members of the Executive Board, plus the governors of the National Central Banks of the 16 Euro area nationsFormulate the monetary policy for the Euro areaExecutive BoardPresident, vice-president and four other members Ensure the day-to-day implementation of the monetary lines of the Governing Council

Governing Council Executive Board and General CouncilThe General CouncilPresident, vice-president of the ECB, representatives of the 16 Euro area countries and the 11 non-Euro zone EU Member States.Performs advisory tasks to the ECB, collects statistical information and standardizes the accounting operations of the NCBs

How Do National Central Banks Operate Within the EurosystemPlay an essential role in the ESCBExercise powers delegated by the Governing CouncilDeutsche BundesbankTill 2008 Bundesbank had nine regional offices and 47 branches throughout Germany

How does the ECB differ from the Bundesbank?Implements the Eurosystem monetary policy as laid down in the EC TreatyClears house for its member banks and the bankers bankerThe Bundesbank is the states banker and Federal Governments fiscal agentManages the currency reserves of GermanyCooperates with other international institutions

How Independent is the ECB?Most independent in the worldMembers of the Executive Board have long termsDetermines own budgetLess goal independentPrice stabilityCharter cannot by changed by legislation; only by revision of the Maastricht Treaty

Bank of CanadaEssentially controls monetary policyBank of EnglandHas some instrument independenceBank of JapanRecently (1998) gained more independence Central Banks in Transition EconomiesCzech, Bulgarian and Hungarian central banksCentral Banks Round The World

The degree of independence of their central banks highly relates to the level of development of the financial sector and political institutionsOne main barrier is the low level of capitalization and their inability to generate sources of revenue.Central Banks in Developing Countries and Emerging Economies

Peoples Bank of ChinaMultinational Central Banks in Developing countriesCentral Bank Reforms in South AmericaCurrency Unions in Developing NationsThe Trend Toward Greater IndependenceCentral Banks in Developing Countries and Emerging Economies

Explaining Central Bank Behavior Theory of bureaucratic behavior: objective is to maximize its own welfare which is related to power and prestigeFight vigorously to preserve autonomyAvoid conflict with more powerful groupsDoes not rule out altruism

Case for IndependencePolitical pressure would impart an inflationary bias to monetary policyPolitical business cycleCould be used to facilitate Treasury financing of large budget deficits: accommodationToo important to leave to politiciansthe principal-agent problem is worse for politicians

Case Against IndependenceUndemocraticUnaccountableDifficult to coordinate fiscal and monetary policyHas not used its independence successfully

Chapter SummaryThe Federal Reserve System was created in 1913 to lessen the frequency of bank panics.The Federal Reserve is more independent than most agencies of the U.S. government but is still subject to political pressure.

Chapter Summary cont.The European System of Central Banks has a fairly similar structure to the Federal Reserve System. Each member country has a National Central Bank, and an Executive Board of the European Central Bank being located in Germany. The Governing Council is made up of 6 members of the Executive Board, and the Presidents of the National Central Banks.

Chapter Summary cont.Most developing nations and transition economies have reformed their central banks and granted them increasing levels of independence. Central banks are gaining more independence throughout the world. Greater independence has been granted to the Bank of England and Bank of Japan. What are the pros and cons for independent banks?

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