Chapter 16. Structure of Central Banks & the Federal Reserve System

1. Chapter 16. Structure of Central Banks & the Federal Reserve System • Origins • Structure • Comparison to ECB

2. Origins • “the Fed” • Federal Reserve Act 1913 • response to panic of 1907 • obstacles • fear of centralized power • solution • decentralized structure

3. Structure • 3 main parts: • Federal Reserve Banks • Board of Governors • FOMC

4. Federal Reserve Banks • 12 regional banks • serve the member banks in that district -- all national banks -- option for state banks -- 33% of commercial banks

6. who controls district banks? • member banks are part owners -- 6% dividends -- part of Board of directors • other officers chosen by Board of Governors

7. functions • clear checks • provide/destroy currency • research regional economy -- Beige Book • economic education • monetary policy • approval of mergers, purchases • FRBNY is most important district bank

8. 1980 DIDMCA • all depository institutions • keep reserves on deposit at district bank • have access to discount loans

9. Board of Governors • 7 governors • 14-yr. terms (nonrenewable) • 1 chair -- 4-year renewable term -- Alan Greenspan (1987-2006) -- Ben Bernanke (2006-

10. Board helps set monetary policy • on FOMC • sets reserve requirement • approves district discount loan rates • Board staff economists • economic research • collect data

11. Board enforces regulations • permissible activities for banks • Consumer protections • stock margin requirements • final say in bank mergers

12. FOMC • Federal Open Market Committee • 12 members • 7 governors • FRBNY President • 4 other district bank presidents rotate

13. meet every 6 weeks • assess condition of economy • vote on monetary policy -- announce decision later that day (since 1996)

14. FOMC & monetary policy • voting on federal funds rate target • voting on open market operations -- buying & selling of Treasury debt by the Fed

15. Fed structure & reality • appears decentralized • but power concentrated w/ • Board of governors • Chair

16. Fed Independence • Fed has much more independence in decisions than other federal agencies • Fed governors do NOT serve “at pleasure of the President” • Fed decisions not subject to approval of President or Congress

17. sources of independence • structure • Board of governors have long, nonrenewable terms • popularity of chairman w/ financial sector

18. financing • Fed is self-financing -- Treasury debt -- discount loans -- other services • Does not depend on Congress for funding

19. Fed independence is not complete! • Congress has ultimate power to limit or eliminate Fed • chairman testifies before Congress every 6 months

20. Is independence good? • common in industrialized countries • but it is undemocratic

21. Pros • political goals often conflict with economic goals • short term vs. long term goals • Congress: re-election • Fed: free to pursue unpopular policies in short-run -- price stability may require slower economic growth

22. example: 1981-82 recession • Fed chair Paul Volcker slowed down economy to control inflation • “Volcker Recession”: ’81-’82 • results of low inflation: • 2 long expansions in 1980s, 1990s

24. Cons • Fed not accountable for mistakes • stuck with bad governors • independence is no guarantee of success • Fed did not prevent bank failures of Great Depression • inflation of 1970s

25. independent Fed does not coordinate policy with Congress • monetary vs. fiscal policy

26. ECB: a comparison • European Central Bank • 1999 • Central bank for monetary policy of 12 euro countries • A larger economy than U.S.

27. ECB structure • Executive board • like Board of Gov • National Central Banks (NCB) • Like Federal Reserve Banks • Governing Council • Like FOMC

28. Key differences • ECB does NOT regulate financial institutions • ECB gets budget from NCB • No voting on the Governing Council • VERY independent • Countries cannot change ECB decisions