1. Chapter Sixteen Chapter 16
The Structure of Central Banks: The Federal Reserve and the European Central Bank

2. Learning Objectives Structure of the Federal Reserve System.
The effectiveness of the Federal Reserve System.
The structure of the Eurosystem.

3. The Structure of the Federal Reserve System
Twelve regional Federal Reserve Banks, distributed throughout the country;
Board of Governors of the Federal Reserve System, in Washington, D.C.; and
The Federal Open Market Committee.

4. The Structure of the Federal Reserve System
All national banks are required to belong to the Federal Reserve System.
State banks that receive their charters from individual state banking authorities have the option of joining, but fewer than 20% do.

5. The Federal Reserve System: The Twelve Districts

6. The Federal Reserve Banks
Reserve Banks are part public and part private.
Federally chartered banks and private
Nonprofit organizations, owned by the commercial banks in their districts.

7. The Federal Reserve Banks
Six directors are elected by the commercial bank members of the Reserve Bank
Three directors representing the Reserve Bank and
Three representing the public.
The remaining three directors are appointed by the Boards of Governors.
Each Reserve Bank has a president who is appointed for a five-year term by the bank’s board of directors with the approval of the Board of Governors.

8. The Federal Reserve Banks
The Government’s Bank
Issues currency,
Maintains the Treasury’s account, and
Manages the Treasury debt.
The Bankers’ Bank
Holds Reserve Deposits,
Operates the Payments System,
Makes Discount Loans at the Discount Rate,
Supervises and regulates financial institutions, and
Collects Data.

9. The Federal Reserve Banks
Reserve Banks play an important role in formulating monetary policy:
Representation on the Federal Open Market Committee (FOMC), and
Through their participation in setting the discount rate.
The New York Fed:
Executes Open market Operations.
Runs Fedwire: Interbank Funds Transfer System

10. The Board of Governors
The seven members, appointed by the president and confirmed by the U.S. Senate for 14-year terms.
The long terms are intended to foster independence by protecting the board from political pressure.
The terms are staggered limiting any individual president's influence over the membership.

11. The Board of Governors Duties of the governors are to:
Set the reserve requirement,
Approve or disapprove discount rate recommendations,
Rule-writing agency for consumer credit protection laws
(with enforcement by the Consumer Financial Protection Bureau created by the Dodd-Frank Act),

12. The Board of Governors Duties of the governors (cont.)
Along with the Reserve Banks, regulate and supervise the banking system,
Invoke the emergency powers to lend to nonbanks (powers were curtailed by the Dodd-Frank Act),
Analyze financial and economic conditions, and
Collect and publish detailed statistics.

13. The Federal Open Market Committee
When the press discusses the Fed, its the Federal Open Market Committee (FOMC).
sets the interest rates and adjusts the Fed’s balance sheet to control the availability of money and credit to the economy.
It has existed since 1936 and has 12 voting members:
The seven governors,
The president of the Federal Reserve Bank of New York, and
A rotating selection of 4 of the remaining 11 Reserve Bank presidents.

14. The Federal Open Market Committee
The chair of the Board of Governors chairs the FOMC.
The committee’s vice chair is the president of the Federal Reserve Bank of New York.
While only 5 of the 12 Reserve Bank presidents vote at any one time, all of them participate in the meeting.

15. The Federal Open Market Committee
Controls the federal funds rate.
This is the rate banks charge each other for unsecured overnight loans on their excess deposits at the Fed.
Intent - by controlling the federal funds rate, the FOMC influences real growth.

16. The Federal Open Market Committee
The FOMC currently meets 8 times a year.
Committee can confer and change policy over the telephone.
The financial crisis of prompted 12 unscheduled FOMC meetings.
The primary purpose of a meeting is to decide on the target interest rate.
Gives directive to the system open market account manager who works for the Federal Reserve Bank of New York to carry out OMO.

17. The Federal Open Market Committee
Where does the committee’s power lie and who controls interest-rate decisions?
The chair is the voice of the Fed.
The governors make up a majority of the committee.
The chair sets the agenda for FOMC meetings, determines the order in which people speak, and proposes the FOMC policy statement.
Board of Governors controls the Reserve Banks’ budgets and salaries of their presidents.

18. Assessing the Federal Reserve System’s Structure
Previous chapter, an effective central bank is one in which:
Policymakers are independent of political influence,
Make decisions by committee,
Are accountable and transparent, and
State their objective(s) clearly.
Evaluate the Fed using these criteria.

19. Independence from Political Influence
There are three criteria for judging central bank independence:
Budgetary independence,
Irreversible decisions, and
Long terms in office.
The Fed meets each of these.

20. Independence from Political Influence
The Fed controls its own budget.
substantial revenue comes from interest on government securities it holds and fees charged to banks for payments system services.
typically 95% of its income is returned to the U.S. Treasury each year.
Interest rate changes are implemented immediately and can be changed only by the FOMC.
The terms of the governors are 14 years, chair’s term is 4 years, and Reserve Bank presidents serve for 5 years.

21. Financially Independent
Earned about $113 Billion on securities.
Less interest on reserves and other expenses
of $13 Billion,
Turned $100 Billion over to Treasury.

22. Decision Making by Committee
The Fed clearly makes decision by committee - the FOMC
While the chair of the Board of Governors may dominate policy decision, the fact that there are 12 voting member provides an important safeguard against arbitrary action.

23. Accountability and Transparency
The FOMC releases huge amount of information to the public:
Announcement of policy decision and reasoning,
Detailed minutes of the meeting 3 weeks later,
Word-for-word transcript 5 years later,
Twice-yearly “Monetary Policy Report to the Congress”,
The chair’s appearance before Congress to discuss the state of the nation’s economy, and
Numerous speeches given by the chair, other governors and Reserve Bank presidents.

24. Two events provide the foundation for Fed independence:
In 1935, political appointees were removed from the Federal Reserve Board, and the FOMC was created.
In 1951, President Truman supported the Fed’s refusal to purchase Treasury securities that the Secretary of the Treasury requested they buy.
The president, the secretary of the Treasury, and the Federal Reserve chair reached an “accord” and issued a joint announcement establishing the FOMC’s independence in setting interest rates and controlling the rate of monetary expansion.

25. Fed’s Policy Framework
The Congress has set the Fed’s objectives:
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

26. European Central Bank(ECB)
European Monetary Union began January 1, 1999
Euro notes and coins began circulation January 1, 2002
19 of 28 countries in the European Union use the Euro

27. The European Central Bank
The agreement to form a European monetary union was formalized in the Treaty of Maastricht.
The ECB and the NCBs of the 19 countries that participate in the monetary union make up what is known as the Eurosystem.
They share a common currency and common monetary policy.
European Central Bank (ECB) is the institution that is responsible for monetary policy in the euro area.

28. Organizational Structure
The ECB mirrors the structure of the Federal Reserve System in several ways.
A six-member Executive Board of the ECB, similar to the Board of Governors;
The National Central Banks play many of the same roles as the Federal Reserve Banks; and
The Governing Council formulates monetary policy as the FOMC does.

29. Organizational Structure
The Executive Board has a president and a vice president who play the same role as the Fed’s Board of Governors.
ECB executive board members are appointed by a committee composed of the heads of state of the countries that participate in the monetary union.

30. Organizational Structure
The ECB and the NCBs together perform the traditional operational functions of a central bank.
They use interest rates to control the availability of money and credit in the economy, and
They are responsible for the smooth operation of the payments system and the issuance of currency.
The National Central Banks continue to serve as bankers to the banks and governments in their countries.

31. Organizational Structure
Monetary policy
The Governing Council is composed of the six Executive Board members and the governors of 15 of the 19 central banks in the euro area.
Meetings are held monthly to determine policy

32. Organizational Structure
The Governing Council members are charged with setting policy for the euro area as a whole, regardless of economic conditions in the individual countries.
The decisions are made for the benefit of the euro area, not for individual countries.
Decisions are made by formal votes of the Council, but are not published.
Ensure that Governing Council members focus on setting policy for the euro area as a whole

33. Organizational Structure
Important safeguards were included in the Treaty of Maastricht to ensure the central bank’s independence.
There are terms of office (8 year term).
The treaty states explicitly that the Governing Council cannot take instructions from any government, so its policy decisions are irreversible.

34. The Price Stability Objective and Monetary Policy Strategy
The Treaty of Maastricht states:
“The primary objective of the European System of Central Banks shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community.”
This includes the objective of sustainable and non-inflationary growth.

35. The Price Stability Objective and Monetary Policy Strategy
The Treaty is widely understood to place priority on price stability as the top objective for the ECB.
The ECB’s Governing Council defines price stability as an inflation rate of close to 2 percent, based on a euro-area-wide measure of consumer prices.
This is the harmonized index of consumer prices (HICP) and is similar to the CPI.
It is the average of retail price inflation in all the countries of the monetary union, weighted by the size of their gross domestic products.

36. The Price Stability Objective and Monetary Policy Strategy
This arrangement has important implications for monetary policy, because there will be times when the proper policy for a small country is to raise interest rates but the proper policy for Germany is to lower them.
Given relative size, a change in inflation or growth in a small country has little impact on the euro area as whole.

37. The Price Stability Objective and Monetary Policy Strategy
The fact that the economically large countries matter much more than the small ones can affect the dynamics of the governing council’s interest rate decisions.
The governing Council’s job is to stabilize prices in the euro area as a whole
one wonders whether activities in the smaller countries might have undue influence on its policy decisions.

38. The Price Stability Objective and Monetary Policy Strategy
Evidence strongly suggests that the ECB is doing the job it is supposed to do.
The Governing council’s policy has been appropriate to the euro area.
It has not been skewed toward smaller countries’ concerns.
The specificity of the price stability objective holds policymakers accountable.
It limits discretion in their decision making.

39. ECB Independence Most independent in the world
Members of the Executive Board have long terms (8 years)
Determines own budget
Less goal independent compared to the Fed
Price stability
Charter cannot by changed by legislation; only by revision of the Maastricht Treaty

40. Bank of Canada 1934 Inflation target since 1991
Target range 1- 3 percent
Monetary Policy aimed at mid-point: 2%
Less goal independence than Fed
(Follow this link and read the BOC statement)

41. Bank of England
1694
Least independent up to Interest rate policy determined by chancellor of the Exchequer.
Policy now with the Bank, but can be overridden by the government.
Inflation target – 2 percent.