pa974-001 monetary policy & financial regulation in a globalized...

PA974 001PA974-001Monetary Policy & Financial Regulation in

a Globalized Economya Globalized Economy

Lecture 18Lecture 18 8 November 2010

Instructor: Menzie ChinnFall 2010Fall 2010

Structure of Central Banks and the F d l R S tFederal Reserve SystemOrigins of the Federal Reserve System

• Resistance to establishment of a central bankFear of centralized powerpDistrust of moneyed interests

• First U.S. experiments with a central bank terminated in 1811 and in 1836in 1811 and in 1836

• No lender of last resortNationwide bank panics on a regular basisPanic of 1907 so severe that the public was convinced a central bank was needed

• Federal Reserve Act of 1913

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Elaborate system of checks and balancesDecentralized

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Federal Reserve Banks• Quasi-public institution owned by private commercial banks

in the district that are members of the Fed system

• Member banks elect 6 directors for each district; 3 more are appointed by the Board of Governors (BoG)

Three A directors are professional bankersThree B directors are prominent leaders from industry, labor, agriculture, or consumer sectorThree C directors appointed by the BoG are not allowed to be officers, employees, or stockholders of banks

• Member banks elect 6 directors for each district; 3 moreMember banks elect 6 directors for each district; 3 more are appointed by the BoG

Designed to reflect all constituencies of the public

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• Nine directors appoint the president of the bank subject to approval by Board of Governors

Functions of the Federal Reserve Banks• Clear checks, issue /withdraw currency

• Administer and make discount loans to banksAdminister and make discount loans to banks

• Evaluate proposed mergers and applications for banks to expand their activitiesbanks to expand their activities

• Act as liaisons between business and the FRS

• Examine bank holding companies and state-chartered member banks

• Collect data on local business conditions

• Use staffs of economists to research topics

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prelated to the conduct of monetary policy

Federal Reserve Banks and Monetary Policyand Monetary Policy

• Directors “establish” the discount rate• Directors establish the discount rate

• Decide which banks can obtain discount loans

• Directors select one commercial banker from each district to serve on the Federal Advisory Council which consults with the Board ofCouncil which consults with the Board of Governors and provides information to help conduct monetary policyy p y

• Five of the 12 bank presidents have a vote in the Federal Open Market Committee (FOMC)

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p ( )

Member Banks

All national banks are req ired to be members• All national banks are required to be members of the Federal Reserve System

C i l b k h t d b t t t• Commercial banks chartered by states are not required but may choose to be members

• Depository Institutions Deregulation and Monetary Control Act of 1980 subjected all banks to the same reserve requirements asbanks to the same reserve requirements as member banks and gave all banks access to Federal Reserve facilities

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Federal Reserve facilities

Board of Governors of the Federal Reserve Systemof the Federal Reserve System

• Seven members headquartered in• Seven members headquartered in Washington, D.C.

• Appointed by the president and confirmed by• Appointed by the president and confirmed by the Senate

• 14 year non renewable term• 14-year non-renewable term

• Required to come from different districts

• Chairman is chosen from the governors and serves four-year term

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Duties of the Board of Governors• Votes on conduct of open market operations

• Sets reserve requirementsq

• Controls the discount rate through “review and determination” processp

• Sets margin requirements

S t l i f id t ffi f h FRB• Sets salaries of president, officers of each FRB, reviews budgets

A li ti f ti iti• Approves mergers, applications for new activities

• Specifies permissible activities of bank holding cos.

12-10• Supervises activities of foreign banks in the U.S.

Chairman of the Board of Governors

Advises the president on• Advises the president on economic policyT tifi i C• Testifies in Congress

• Speaks for the Federal Reserve System p yto the media

• May represent the U.S. in negotiationsMay represent the U.S. in negotiations with foreign governments on economic matters

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Federal Open Market Committee (FOMC)Committee (FOMC)

• Meets eight times a year• Meets eight times a year

• Consists of seven members of the Board of Governors the president of the FederalGovernors, the president of the Federal Reserve Bank of New York and the presidents of four other Federal Reserve banks

• Chairman of the Board of Governors is also chair of FOMC

• Issues directives to the trading desk at the Federal Reserve Bank of New York

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FOMC Meetingg

• Report by the manager of system open market• Report by the manager of system open market operations on foreign currency and domestic open market operations and other related issues

• “Green Book” forecastGo-round

• Current monetary policy and domestic policy directive“Blue book”

• Presentation on relevant Congressional actions• Presentation on relevant Congressional actions• Public announcement about the outcome of

the meeting

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Chairman Runs the Show

Spokesperson for the Fed and• Spokesperson for the Fed and negotiates with Congress and the Presidentthe President

• Sets the agenda for meetings• Speaks and votes first about

monetary policy• Supervises professional economists

and advisers

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How Independent is the Fed?p

• Instrument independent• Instrument independent• Goal independent

Independent re en e• Independent revenue• Structured by legislation from Congress and

accountable for its actionsaccountable for its actions• Presidential influence

Influence on CongressInfluence on CongressAppoints membersAppoints chairman although terms are

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not concurrent

European Central Bankp

Patterned after the Federal Reserve• Patterned after the Federal Reserve• Central banks from each country play

i il l F d b ksimilar role as Fed banks• Executive Board

President, vice-president and four other members Eight year, nonrenewable terms

• Governing Council

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Differences

N ti l C t l B k t l th i• National Central Banks control their own budgets and the budget of the ECB

• Monetary operations are not centralized

D t i d l t• Does not supervise and regulate financial institutions

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Governing Councilg

• Monthly meetings at ECB in• Monthly meetings at ECB in Frankfurt, Germany

• Twelve National Central Bank heads andTwelve National Central Bank heads and six Executive Board members

• Operates by consensusp y• ECB announces the target rate and takes

questions from the media• To stay at a manageable size as new

countries join, the Governing Council will b t f t ti

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be on a system of rotation

ECB Independencep

Most independent in the world• Most independent in the world• Long terms• Determines own budget• Less goal independentg p

Price stability• Charter cannot by changed by• Charter cannot by changed by

legislation; only by revision of the Maastricht Treaty

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Maastricht Treaty

Central Bank Behavior

Th f b ti b h i• Theory of bureaucratic behavior—objective is to maximize its own welfare

hi h i l t d t d tiwhich is related to power and prestigeFight vigorously to preserve autonomyAvoid conflict with more powerful groups

• Does not rule out altruism• Does not rule out altruism

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Case for Independencep

Political press re o ld impart an inflationar• Political pressure would impart an inflationary bias to monetary policy

• Political business cycle

• Could be used to facilitate Treasury financing y gof large budget deficits—accommodation

• Too important to leave to politicians—theToo important to leave to politicians the principal-agent problem is worse for politicians

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Case Against Independenceg p

U d ti• Undemocratic• Unaccountable• Difficult to coordinate fiscal and

monetary policymonetary policy• Has not used its independence

successfullysuccessfully

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