3. Chapter Preview
Central 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).

4. Chapter Preview
In 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.

5. Origins of the Federal Reserve System
Resistance to establishment of a central bank
Fear of centralized power
Distrust of moneyed interests
No lender of last resort
Nationwide bank panics on a regular basis
Panic of 1907 so severe that the public was convinced a central bank was needed
Federal Reserve Act of 1913
Elaborate system of checks and balances
Decentralized

6. Structure of The Federal Reserve System
The writers of the Federal Reserve Act wanted to diffuse power along regional lines
Federal Reserve System include the following entities
The 12 Federal Reserve banks
The Board of Governors of the Federal Reserve System
The Federal Open Market Committee (FOMC)
The Federal Advisory Council
Around 2,900 member commercial banks 5

7. FIGURE 9.1 Federal Reserve System
Source: Federal Reserve Bulletin.

8. Federal Reserve Banks
Quasi-public institution owned by private commercial banks in the district that are members of the Fed system
Member banks elect six directors for each district; three more are appointed by the Board of Governors
Together, these nine directors appoint the president of the bank subject to approval by Board of Governors 7

9. Functions of the Federal Reserve Banks
Clear checks
Issue new currency
Withdraw damaged currency from circulation
Administer and make discount loans to banks in their districts
Evaluate proposed mergers and applications for banks to expand their activities 8

10. Member Banks
All national banks are required to be members of the Federal Reserve System
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 as member banks and gave all banks access to Federal Reserve facilities 9

11. Board of Governors of the Federal Reserve System
Seven members headquartered in Washington, D.C.
Appointed by the president and confirmed by the Senate
14-year non-renewable term
Required to come from different districts
Chairman is chosen from the governors and serves four-year term 10

12. Federal Open Market Committee (FOMC)
Meets eight times a year
Consists 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 banks
The 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 11

13. How Independent is the Fed?
Instrument and goal independence.
Independent revenue
Fed’s structure is written by Congress, and is subject to change at any time.
Presidential influence
Influence on Congress
Appoints members
Appoints chairman although terms are not concurrent 12

14. Structure and Independence of The European Central Bank
The 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 euro
The decision-making process at the EMU takes place at three levels
The Governing Council, the Executive Board and the General Council 13

15. Governing Council Executive Board and General Council
The 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 nations
Formulate the monetary policy for the Euro area
Executive Board
President, vice-president and four other members
Ensure the day-to-day implementation of the monetary lines of the Governing Council 14

16. Governing Council Executive Board and General Council
The General Council
President, 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 15

17. How Do National Central Banks Operate Within the Eurosystem
Play an essential role in the ESCB
Exercise powers delegated by the Governing Council
Deutsche Bundesbank
Till 2008 Bundesbank had nine regional offices and 47 branches throughout Germany 16

18. How does the ECB differ from the Bundesbank?
Implements the Eurosystem monetary policy as laid down in the EC Treaty
Clears house for its member banks and the banker’s banker
The Bundesbank is the state’s banker and Federal Government’s fiscal agent
Manages the currency reserves of Germany
Cooperates with other international institutions 17

19. How Independent is the ECB?
Most independent in the world
Members of the Executive Board have long terms
Determines own budget
Less goal independent
Price stability
Charter cannot by changed by legislation; only by revision of the Maastricht Treaty 18

20. Central Banks Round The World
Bank of Canada
Essentially controls monetary policy
Bank of England
Has some instrument independence
Bank of Japan
Recently (1998) gained more independence
Central Banks in Transition Economies
Czech, Bulgarian and Hungarian central banks 19

21. Central Banks in Developing Countries and Emerging Economies
The degree of independence of their central banks highly relates to the level of development of the financial sector and political institutions
One main barrier is the low level of capitalization and their inability to generate sources of revenue. 20

22. Multinational Central Banks in Developing countries
Central Banks in Developing Countries and Emerging Economies
People’s Bank of China
Multinational Central Banks in Developing countries
Central Bank Reforms in South America
Currency Unions in Developing Nations
The Trend Toward Greater Independence 21

23. Explaining Central Bank Behavior
Theory of bureaucratic behavior: objective is to maximize its own welfare which is related to power and prestige
Fight vigorously to preserve autonomy
Avoid conflict with more powerful groups
Does not rule out altruism 22

24. Case for Independence
Political pressure would impart an inflationary bias to monetary policy
Political business cycle
Could be used to facilitate Treasury financing of large budget deficits: accommodation
Too important to leave to politicians—the principal-agent problem is worse for politicians 23

25. Case Against Independence
Undemocratic
Unaccountable
Difficult to coordinate fiscal and monetary policy
Has not used its independence successfully 24

26. Chapter Summary
The 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.

27. 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.

28. 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?