1. CENTRAL BANKS AND MONETARY POLICY STRATEGY ( Chap. 14; Chap 17, 434-444…454-457)

2. THE STRUCTURE OF CENTRAL BANKS Chapter 17

3. 3 Principles of Monetary Policy Strategy Pt. II Building Credibility 5. Monetary policy is subject to the time- inconsistency problem; Monetary policy is subject to the time- inconsistency problem; 6. Central bank independence helps improve the efficacy of monetary policy. Central bank independence helps improve the efficacy of monetary policy. Expectations, Policy Credibility, and Transparency 3 MishkinMishkin Monetary Policy Strategy: How Did We Get Here?

4. 4 5. Time Inconsistency Central banking goals benefit from anchoring inflation expectations but if inflation expectations become successfully anchored, a myopic policymaker might take advantage to push up output. Low inflation targets might not be time consistent. Since gov’t often has a short-term focus, it might be difficult to build credibility for low inflation expectations. Expectations, Policy Credibility, and Transparency 4

5. Four Principles of Central Bank Design Society should design the state such that central bank is able to resist the short-run imperatives of government but still implement the goals of society Independence Decision Making by Committee Accountability and Transparency Policy Framework

6. Principles of Central Bank Design 1. Independence Strategies for Insulation Policy Independence: Central Bank sets day-to day monetary policy free of direct government control. Policy not reversible. Personal Independence: Long-terms of Office for Central Bank Policymakers, difficult for Central Bankers to be Fired. Revenue Independence: Central Bank has independent sources of revenue.

7. Federal Reserve Structure Board of Governors Washington D.C. (Direct Policy) Regional Banks (Monitor Regional Economy, Local Interbank Payments) New York Fed (Implement Monetary Policy in Financial Markets, Handle FX Transactions)

8. Independence of US Federal Reserve Policy Independence: Monetary policy set by directors of Federal Reserve of USA controlled & Regional Bank Personal Independence: Chairman of Fed serves across Presidential terms. Presidents appointed by executive and approved by legislature. Other policymakers serve terms of either 5 or 14 years. They cannot be fired without votes of ⅔ of Congress. Revenue Independence: Fed earns profits through its payment operations which constitute its budget.

9. Formation of a New Currency The countries of Euroland needed to replace national central banks with a single policy maker. 11 Countries adopt a single currency in 1998, 18 countries by 2013. Structure of the ECB ECB Website

11. Independence of ECB Policy Independence: Monetary policy of ECB controlled by Executive Council & National Bank Presidents. Decisions cannot be reversed by national governments. Personal Independence: National Bank managers serve 5 year terms across Presidential terms. Board members serve 8 year terms. Revenue Independence: Budget provided by national central banks which conduct most profitable operations

14. Independence of Bank of Japan Policy Independence: Monetary policy set by board. Personal Independence: Governor and Board members have terms of five years, appointed by Cabinet approved by Diet and House of Councillors. Budgetary Independence (?): Ministry of Finance must approve budget.

15. Trend toward Independence 1998: Bank of Japan removed from direct control of Ministry of Finance. 1998 Bank of England removed from direct control of the Chancellor of the Exchequer. In 2003, Bank of Korea removed from direct control of Ministry of Economy and Finance.

16. Monitoring the Monitors Reducing the impact of short-term political considerations on decision making is important. But its also important in long-term to insure that central bank serves goals of society and not own self interest.

17. Regulatory Capture Regulator of any industry may end up responding to needs of industry rather than limiting them. Political influence or Hiring of Former Regulators. Buiter: Cognitive Regulatory Capture In USA, Regional Federal Reserves are governed by local banks. http://video.msn.com/video.aspx?mkt=en- us&vid=f52ef280-e022-4fbd-a9a8-2cdcde182235 http://video.msn.com/video.aspx?mkt=en- us&vid=f52ef280-e022-4fbd-a9a8-2cdcde182235

18. More Principles of Central Bank Design How to monitor the central bank. 1. Decision Making by Committee Power should be diffuse within the central bank. 2. Accountability and Transparency Central Banks should make information about their intentions and actions. 3. Policy Framework Banks should have a clear guideline for setting their policy which meets the consensus of society.

19. Decision Making by Committee Interest Rate Setting Each of the Big 3 central banks sets a key interest rate by committee. The decisions of these committees are closely watched. BankCommitteeRate FedFederal Open Market Committee Fed Funds Rate ECBGoverning CouncilMain Refinancing Operation Rate BoJMonetary Policy Committee Uncollateralized Overnight Call Money Rates

20. Accountability and Transparency Publication of Policy Minutes Fed: MinutesMinutes ECB: Doesn’t Publish CritiqueCritique BoJ MinutesMinutes Data, forecasts other research materials, presentations to public and legislature. Federal Reserve must present report to Congress twice per year.

22. Hong Kong Monetary Authority HKMA formed in 1993 with merger of Exchange Fund and Commissioner of Banking to perform role of the central bank. Regulation of the Banking System Operation of the System of Payments Control of the Monetary Base Prior to 1988, interbank settlement done on the books of HSBC

23. Independence of the HKMA? HKMA Policy Objectives “The HKMA is an integral part of the Hong Kong SAR Government. The Chief Executive, appointed by the Financial Secretary, remains a public officer….” “The Exchange Fund Advisory Committee …functions… as a management board of the HKMA. The HKMA is accountable to the public through the Financial Secretary.” Exchange Fund controlled by Financial Secretary. Decision to continue or abandon exchange rate peg lies with Financial Secretary. Existence & Convertibility of HK dollar written into the Basic Law. HKMA has control over its own budget.