Lecture 9 PDF
Lecture 9 PDF
Central Banking
and the Conduct
of Monetary
Policy
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We examine the role of government authorities over the
money supply. We focus primarily on the role of the U.S.
Federal Reserve System, but also examine similar
organizations in other nations. Topics include:
Origins of the Federal Reserve System
Structure of the Federal Reserve System
How Independent is the Fed?
Structure and Independence of the European Central Banks
Structure and Independence of other Foreign Central Banks
Explaining Central Bank Behavior
Should the Fed Be Independent?
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Origins of the Federal
Reserve System
Fear of centralized power and distrust of moneyed
interests guided central bank activities in the 19th century
The First Bank of the U.S. was disbanded in 1811
The Second Bank of the U.S. was disbanded in 1836
when President Andrew Jackson vetoed its renewal.
As a result, banking panics became regular events,
absent a lender of last resort, culminating in the panic of
1907.
Widespread bank failures and depositor losses convinced
the U.S. that a central bank was needed.
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Federal Reserve Act of 1913
Fear of a central authority was rampantpeople
worried that powerful Wall Street interests would
manipulate the system.
Questions arose as to whether such a monetary
authority would be private or a government
institution.
The Federal Reserve Act of 1913 was a
compromise that created the Federal Reserve
System, including elaborate checks and balances.
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INSIDE THE FED: The Political
Genius of the Funders of the FRS
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Structure of the Federal
Reserve System
Design was intended to diffuse power along the following
dimensions:
Regions of the U.S.
Government and private sector interests
Needs of bankers, businesses, and the public
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Structure of the Federal
Reserve System
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Structure
of the
Federal
Reserve
System
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Structure of the Federal
Reserve System
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Federal Reserve Banks
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Federal Reserve Bank
Functions: Monetary Policy
Establish the discount rate at which member
banks may borrow from the Federal Reserve
Bank (subject to BOG review)
Determine which bank receive loans
Elect one member to the Federal
Advisory Council
Five of the 12 bank presidents vote in the Federal
Open Market Committee
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The FRB of New York
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The FRB of New York
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The FRB of New York
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Member Banks
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Member Banks
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Board of Governors
The seven governors are appointed by the President,
and confirmed by the Senate, for 14-year terms on a
rotating schedule.
All Board members are members of the FOMC.
Effectively set the discount rate.
Serve in an advisory capacity to the President of the United
States, and represent the U.S. in foreign economic matters.
Other duties as established by legislation (e.g., Regulation
Q, Credit Control Act of 1969).
Set margin requirements for stock purchases.
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The research staff
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Federal Open Market Committee
Make decisions regarding open market operations, to
influence the monetary base.
The chairman of the BOG is also the chair of this
committee
Open market operations are the most important tool that
the Fed has for controlling the money supply (along with
reserve requirements and the discount rate)
All actions are directed the Federal Reserve Bank of New
York, where securities are bough / sold as required.
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Federal Open Market
Committee Meeting
Meet eight times each year (about every
six weeks)
Important agenda items include
Reports on open market operations (foreign and
domestic)
National economic forecasts are presented
Discussion of monetary policy and directives, including
views of each member
Formal policy directive made
Post-meeting announcements, as needed
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Inside the Fed: the books
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Chairman of the
Federal Reserve System
Spokesperson for the entire Federal Reserve
System, and supervises the Boards staff
Negotiates, as needed, with Congress and the
President of the United States
With these, the chairman has effective control
over the system, even though he doesnt have
legal authority to exercise control over the system
and its member banks.
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How Bernankes Style Differs
from Greenspans
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How Independent is the Fed?
A broad question of policy for the Federal Reserve
Systems is how free the Fed is from presidential and
congressional pressure in pursuing its goals.
Instrument Independence: the ability of the central bank to
set monetary policy instruments.
Goal Independence: the ability of the central bank to set
the goals of monetary policy.
Evidence suggests that the Fed is free along both
dimensions. Further, the 14-year terms (non-renewable)
limit incentives to curry favor with either the President
or Congress.
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How Independent is the Fed?
Other Evidence
The Fed usually generates revenue in excess of its
expenses, so it is not typically under appropriations
pressure.
However, Congress can enact legislation to gain control of
the Fed, a threat wielded as needed. For example, the
House Concurrent Resolution 133 requires the Fed to
announce its objective growth rate for the money supply.
Presidential appointment clearly sets the direction of the
Fed.
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The European Central Bank
Founded (as it currently exists) in 1999 by a treaty
between the European Central Bank (ECB) and the
European System of Central Banks (ESCB).
The ECB is housed in Frankfurt, Germany.
Executive board consists of the president, vice president,
and four members, all serving eight-year terms.
The policy group consists of the executive board and
governors from the 11 member countries central banks.
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The European Central Bank
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The European Central Bank
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The European Central Bank
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The European Central Bank
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Structure and Independence of
Other Foreign Central Banks
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Bank of Canada
Founded in 1934
Directors are appointed by the government for three-year
terms, and they appoint a governor for a seven-year term.
A governing council is the policy-making group
comparable to the FOMC.
In 1967, ultimate monetary authority was given to the
government. However, this authority has never been
exercised to date.
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Bank of England
Founded in 1694
The Court (like our BOG) consists of the governor, two
deputy governors (five-year terms), and 16 nonexecutive
directors (three-year terms).
The Monetary Policy committee compares with the U.S.
FOMC, consisting of the governor, deputy governors, two other
central bank officials, plus four outside economic experts.
The Bank was the least independent of the central banks, until
1997, when it was granted authority to set interest rates.
The government can step in under extreme circumstances,
but has never done so yet.
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Bank of Japan (Nippon Ginko)
Founded in 1882
The Policy Board sets monetary policy, and consists of the
governor, two vice governors, and six outside members.
All serve five-year terms.
The Bank of Japan Law (1998) gave the Bank
considerable instrument and goal independence.
Japans Ministry of Japan can exert authority through its
budgetary approval of the Banks non-monetary spending.
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Trend toward Independence
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Explaining Central Bank
Behavior
Two competing theories try to explain the
observed behavior of central banks:
Public Interest View: the central bank serves the public
interest.
Theory of Bureaucratic Behavior: the central bank will
seek to maximize its own welfare.
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Transparency
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Transparency
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Case for Independence
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Case for Independence
The notion of the political business cycle stems
from the previous argument.
Expansionary monetary policy leads to lower
unemployment and lower interest ratesa good idea
just before elections.
Post-election, this policy leads to higher inflation, and
therefore, higher interest rateseffects that hopefully
disappear (or are forgotten) by the next election.
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Case for Independence
Other arguments include:
The Treasury may seek to finance the government
through bonds purchased by the Fed. This may lead to
an inflationary bias.
Politicians have repeatedly shown an inability to make
hard choices for the good of the economy that may
adversely affect their own well-being.
Its independence allows the Fed to pursue policies
that are politically unpopular, yet in the best interest of
the public.
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Case Against Independence
Some view Fed independence as undemocratican
elite group controlling an important aspect of the economy
but accountable in few ways.
If this argument seems unfounded, then ask why we dont
let the other aspects of the country be controlled by an
elite few. Are military issues, for example, any
less complex?
Indeed, we hold the President and Congress accountable
for the state of the economy, yet they have little control
over one of the most important tools to direct
the economy.
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Case Against Independence
Further, the Fed has not always been successful
in the past. It has made mistakes during the Great
Depression and inflationary periods in the 1960s
and 1970s.
Lastly, the Fed can succumb to political pressure
regardless of any state of independence. This
pressure may be worse with few checks and
balances in place.
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Central Bank Independence and
Macroeconomic Performance
Throughout the World
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Chapter Summary
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Chapter Summary (cont.)
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Chapter Summary (cont.)
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Chapter Summary (cont.)
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