14

1
14 Central Banks

• Cecchetti Chapter 15

2
Early History of the Fed

• Federal Reserve Act 1914
• Created as a bureau of the Treasury and the
  Secretary of Treasury was required to serve as an
  ex officio Chairman of the Federal Reserve Board.
• Act signed by President Wilson

3
Central Banks

• Primary reason central banks exist print
  currency and control monetary policy
• Free markets cannot do this adverse selection
• Bankers Bank
• Provide loans during times of financial stress
• Manage the payments system
• Regulate commercial banks

4
How does the Fed Work?

• When the Fed wishes to increase the money supply
  (shift AD curve to right)
• Buys U.S. bonds from commercial banks
• When the Fed wishes to decrease the money supply
  (shift AD curve to left)
• Sells U.S. bonds from commercial banks
• Together these are called open market
  operations

5
Money Supply and Interest Rates

• When the money supply increases,
• interest rates drop
• inflation pressure increases
• When the money supply decreases,
• interest rates increase
• Inflation pressure decreases

6
Central Bank Objectives

• Low stable inflation
• High Stable Real Growth
• Stability of the financial system
• Interest Rate Stability

7
Effective Central Banks

• Independence from political pressure
• Control over own budgets
• Policies must be irreversible
• Decision making by committee
• Risk of putting one person in charge can be high
• Accountability and Transparency
• Establish a system of goals
• Publicly report progress

8
(No Transcript)
9
Independent Central Banks
Do independent central banks just keep the money
supply too low (line A)? Do central banks run by
political leaders do a better job keeping the
economy Running at full capacity (line B)?
P
B
A
Aggregate Output, Y
10
Independent Central Banks
Empirical Evidence There is no difference in
unemployment rates across countries with
independent central banks (line A) and
without Independent central banks (line
B). Countries without independent central
banks Just have higher inflation.
B
P
A
Aggregate Output, Y
11
Banking Act of 1935

• Federal Reserve reorganized
• Board of Governors shall be composed of seven
  members, appointed by President
• Among these is appointed a Chairman and Vice
  Chairman
• First Chairman Mariner S. Eccles
• A principal sponsor of the act
• Was serving as an assistant to the Secretary of
  the Treasury and a Governor of the Federal
  Reserve Board

12
Mariner S. EcclesFed Chairman 1936 1948Fed
Governor 1948-1951
13
Federal Reserve Eccles Building
14
Eccles and Fed independence

• 1947 Inflation at 14
• 1948 Inflation at 8
• Treasury wanted to keep rates low
• Facilitate war debt funding
• Fed (Eccles) wanted to contain inflation
• Congress supported Eccles
• Truman declines to reappoint Eccles in 1948

15
Eccles and Fed Independence

• Thomas McCabe Chairman 1948-1951
• 1951 Same argument between Treasury and Fed
  emerged
• Truman calls FOMC to Whitehouse
• Snyder, Secretary of Treasury, announces that
  rates will be kept at 2.5

16
Eccles and Fed Independence

• Eccles releases confidential minutes of White
  House meeting to public
• Asks Truman to resolve the conflict
• Truman had William McChesney Martin, a Treasury
  Official, negotiate.

17
Eccles and Fed Independence

• Martin made the Chair of the Fed in 1951.
• Accord of 1951 was signed making clear that the
  Fed was independent of the Treasury.

18
Federal Reserve System

• Central Government Agencies
• Board of Governors
• 12 regional banks
• FOMC
• Private Banks
• Advisory Committees

19
Federal Reserve Regional Banks
20
Board of Governors

• Seven Governors
• Appointed by President
• Confirmed by Senate
• Serve 14 year terms
• Terms staggered with a term beginning once every
  two years
• Chairman and Vice Chairman
• Appointed by president from among the seven
• Four year terms
• No two governors can serve from the same district

21
Board of Governors Duties

• Analyzes financial and economic conditions
• Administers consumer credit protection laws
• Supervises and regulates the regional Reserve
  Banks, including budgets and salaries
• Sets the reserve requirement
• Approves bank merger applications
• Regulates and supervises the banking system
• Collects and publishes data

22
Regional Banks

• Federally charted banks and private, nonprofit
  organizations owned by commercial banks
• Managed in part by Board of Directors
• Nine members
• Some chosen by private banks
• Others chosen by Board of Governors
• Managed in part by a president
• Appointed for a five-year term by banks board of
  directors with approval from Board of Governors

23
Regional Banks

• As the bank for U.S. government
• Issue new currency and destroy old currency
• Maintain U.S treasury bank account/borrowings
• As the bankers bank
• Hold deposits (reserves) which pay zero interest
• Operate payments network (checks, debit cards, .
  . .)
• Make discount loans
• Supervise and regulate financial institutions
• Collect data

24
Federal Reserve Bank of New York

• Point of contact with financial markets
• Open market operations
• Treasury securities are auctioned

25
Federal Open Market Committee

• Has twelve voting members
• Seven governors
• President of FRB New York
• Four Reserve Bank Presidents
• Serve one-year terms
• President of FRB Chicago and Cleveland vote every
  other year
• Other nine presidents vote one out of every three
  years

26
Federal Funds Rate

• Federal Funds Rate
• Rate at which banks borrow from each other
  overnight
• Determined by supply and demand
• When there are excess reserves, FF rate is low
• When there is low supply of reserves, FF rate is
  high

27
Discount Rate

• Rate at which banks can borrow money from Fed at
  discount window.
• Set by regional banks boards of directors
• Set automatically at a premium above the Federal
  Funds rate.

28
FOMC

• Targets Federal Funds Rate
• If prices are sticky than they influence the
  real rate
• Real Nominal Inflation
• Policy decision directs staff at FRB New York to
  engage in open market operations

29
Federal Open Market Committee

• Beige Book
• Published two weeks before meeting
• Anecdotal information about economic conditions
• Only document released to public before meeting
• Green Book
• Distributed Thursday before meeting
• Board Staffs economic forecast for next few
  years
• Blue Book
• Distributed Saturday before meeting
• Discussion of current markets and policy options

30
Power Within the FOMC

• Governors make up a majority
• Green and Blue books prepared by Fed staff
• Before formal vote, chair makes recommendation
  followed by others saying yes or no
• All bank presidents participate
• Chair votes first
• Board controls Regional Bank budgets and salaries
• To impact policy, governors and bank presidents
  must generate support through statements in
  meeting and in public.

31
Assessment of Fed Structure

• Independence
• Control own budget
• Decisions cant be over-turned
• Terms are long
• Structure can only be changed by congressional
  legislation
• Decision by committee

32
Assessment of Fed Structure

• Accountability and transparency
• Load of information on web sites
• Immediately after meeting announcement of policy
  decision and explanatory statement
• Minutes published about two weeks later
• After 5-years word-for-word transcript, Blue and
  Green Books
• Twice yearly Monetary Report to Congress (see
  next slide)
• Is it the right information?
• No press conference
• Blackout period
• 5-year delay for transcript, Green and Blue Books
  
• Inflation Targets?

33
Press Release 11/14/2007

• The Federal Open Market Committee (FOMC)
  announced on Wednesday that, as part of its
  ongoing commitment to improve the accountability
  and public understanding of monetary policy
  making, it will increase the frequency and expand
  the content of the economic projections that are
  made by Federal Reserve Board members and Reserve
  Bank presidents and released to the public.

34
Press Release 11/14/2007

• The FOMC will
• compile and release projections four times each
  year rather than twice a year.
• The projection horizon will be extended to three
  years, from two.
• FOMC meeting participants will now provide
  projections for
• inflation
• real gross domestic product growth,
• the unemployment rate
• core inflation.