Euro Challenge Orientation: Monetary Policy Basics Miami Branch Euro Challenge Orientation: Monetary Policy Basics Wednesday, January 27, 2010

Disclaimer: The views expressed are those of the presenter and do not necessarily reflect those of the Federal Reserve Bank of Atlanta or the Federal Reserve System.

History

History of the Fed 1791 – 1811: First Bank of the United States Nation’s first Central Bank Helps unify country’s economy Faced major opposition 20 year charter not renewed 1816 – 1836: Second Bank of the United States Serves same functions as First Bank Financed debt from War of 1812 Bank President Nicholas Biddle and U.S. President Andrew Jackson at odds over bank Central banking was not revived for more than 75 years

History of the Fed 1863: The National Banking Act was passed Nationally-chartered banks Bank notes backed by U.S. government securities 1913: Federal Reserve System Established Nation’s third central bank Banking Panic of 1907 raises need for central bank Created safer and more stable monetary and banking system The Fed has a 20 year charter, however, McFadden Act of 1927 gave Fed permanence

History of the ECB 1952: The European Coal & Steel Community Founding members were Belgium, Germany, France, Italy, Luxembourg and the Netherlands Bank To withdraw resources used for war to preserve peace 1958: European Economic Community and European Atomic Energy Community (Euratom) 1967: European Communities (now known as the European Union) ECSC, EEC and Euratom merged Joint decisions and policies for many industries

History of the ECB 1988: European Council confirmed EMU EC central bank governors formed a committee of monetary policy experts Resulted in the Delors report that details a three step program to achieve EMU 1992: Treaty on European Union Established the European Union Added chapter on monetary and economic policy 1999: European Central Bank opened Currency among initial 11 member banks was fixed Single monetary policy 2002: Introduction of Euro Currency and Coin

Structure and functions

Federal Reserve System Structure The Board of Governors 12 Federal Reserve Banks 24 Branches European Central Bank Structure Executive Board 16 Eurosystem Banks (have adopted the euro) 27 EU Member Central Banks

Federal Reserve Board of Governors European Central Bank Seven members Appointed by U.S. president and confirmed by the Senate Staggered, 14-year terms Ben Bernanke, Chairman European Central Bank Executive Board Six members Appointed by the Heads of State of member countries 8 year term Jean Claude Trichet, President

Federal Reserve Goal European Central Bank Goal To promote economic growth, stable prices and maximum employment. Why? Multiple bank failures throughout history due to inflexible financial system & periods of high unemployment European Central Bank Goal To maintain price stability Why? Due to Germany’s hyperinflation in the 1920’s with the issuance of the 50 million Mark note

Federal Reserve Primary Functions European Central Bank Conduct monetary policy Supervise and regulate the banking system Provide payment services European Central Bank Primary Functions Conduct monetary policy Conducting foreign exchange operations Promote an efficient payment system Hold and manage foreign reserves

Federal Reserve Monetary Policy FOMC European Central Bank The Seven Governors have voting authority Five Reserve Bank Presidents have voting authority (New York and four others on a rotating basis) The Seven non-voting Presidents participate fully in FOMC Meetings The FOMC meets eight times per year European Central Bank Monetary Policy Governing Council Six members of the Executive Board 16 Governors of National Central Banks Meet twice a month, first meeting to conduct monetary policy, second to discuss ECB management

Conclusion Both central banks try to achieve broadly similar objectives even if their strategies are different.

Economic Indicators and statistics

Why do Central Banks use economic indicators? Essential to making effective monetary policy Both the U.S. dollar and Euro are fiat currencies Value is not pegged to commodities, but rather to national wealth If money supply is not proportionate to national wealth, then either inflation or deflation can result M x V = P x Q M = Supply of Money V = Velocity of Money P = Price levels Q = Quantity of goods and services

Remember: M x V = P x Q How can a central bank affect the economy? Let’s try a little simulation… Remember: M x V = P x Q Which variable(s) are we adjusting? What is the impact?

Gross Domestic Product - GDP What is GDP? Measures the total value of goods and services produced within a country in a given period Also measures a country’s total income What is growth rate? The percent increase or decrease of GDP from a previous measurement cycle Why use GDP per capital for cross country comparison? Allows you to measure apples to apples

What are the components of GDP? Personal Consumption Expenditures Investment (I) Government (G) Net Exports (NX) Fixed Investment Inventories Exports Imports Nonresidential Residential GDP = C + I + G + NX

Unemployment What does unemployment measure? Measures the percent of those in the labor force (excluding discouraged workers) that are unemployed Are there different types of unemployment? Cyclical – unemployment rises with a downturn in the economy and rises when the economy improves Frictional – individuals who are transitioning, entering the workforce for the first time or re-entering, usually voluntary Structural – a mismatch between skills and availability of workers and vacancies in the job market.

Inflation and Deflation What is inflation? A situation in which the economy’s overall price level is rising What is deflation? A situation in which the economy’s overall price level is decreasing What are the measures of inflation/deflation? Consumer Price Index Producer Price Index Personal Consumption Expenditures Price Index

Inflation The job of central banks is to keep inflation low by influencing the money supply. This is accomplished by through open markets operations, setting interest rates and bank reserve requirements.

Comparison of Economies   Population GDP* GDP Growth Rate* GDP per Capita* Unemploy-ment Rate* Inflation Rate* Central Bank Discount Rate EU 491 MM $14.69 T 1.5% $33,800 7.2% 3.7% 2.0% United States 303.8 MM $14.58 T 1.4% $48,000 0% .25% China 1.3 B $7.8 T 9.8% $6,100 4.0% 6.0% 5.31 Japan 127.8 MM $4.48 T 70.0% $35,300 4.2% 1.8% 0.1% Germany 82.3 MM $2.86 T 1.7% $34,800 10.8% 2.8% N/A United Kingdom 60.9 MM $2.27 T 1.1% $37,400 5.5% 3.8% Russia 140.7 MM $2.22 T $15,800 6.2% 13.9% 13.0% France 64 MM $2.09 T 0.9% $32,700 7.5% 3.4% Italy 58.1 MM $1.8 T 0.0% $31,000 6.8% 3.6% Spain 40.4 MM $1.37 T 1.3% $34,100 10.9% 4.4% *2008 estimates Ref: www.cia.gov www.tradingeconomics.com/economics/interest-rate.aspx

ECB Member Countries Population GDP* GDP Growth Rate* GDP per Capita*   Population GDP* GDP Growth Rate* GDP per Capita* Unemploy-ment Rate* Inflation Rate* EU 491 MM $14.69 T 1.5% $33,800 7.2% 3.7% Germany 82.3 MM $2.86 T 1.7% $34,800 10.8% 2.8% France 64 MM $2.09 T 0.9% $32,700 7.5% 3.4% Italy 58.1 MM $1.8 T 0.0% $31,000 6.8% 3.6% Spain 40.4 MM $1.37 T 1.3% $34,100 10.9% 4.4% Netherlands 16.6 MM $687 B 2.1% $41,300 4.6% 2.6% Belgium 10.4 MM $398 B $38,300 7.0% Greece 10 MM $351 B $32,800 8.0% Austria 8.2 MM $325 B $39,600 Portugal 10.6 MM $245 B $22,000 7.6% 2.9% Finland 5.2 MM $201 B 2.4% $38,400 6.5% 4.2% Ireland 4.1 MM $198 B -0.7% $47,800 6.2% 4.0% Slovakia 5.4 MM $123 B $22,600 7.4% 4.7% Slovenia 2 MM $61 B 4.5% $30,800 6.7% 6.0% Luxembourg 486,006 $41 B $85,100 Cyprus 792,604 $23 B $29,200 3.8% 5.1% Malta 403,532 $9 B 3.0% $24,200 6.4% *2008 estimates Ref: www.cia.gov

QUESTIONS