Money and Banking: Chapter 13 (Central Banks and the Federal Reserve System)

The Board of Governors are actively involved in monetary policy in the following ways

1. All seven governors are embers of the FOMC and vote on the conduct of open market operations 2. It sets reserve requirements 3. It controls the fixed amount by which the discount rate exceeds federal funds 4. the chair of Board advises the president Pg. 298

The initial diffusion of power for the Federal Reserve Act created. 1. 2. 3. 4. 5.

1. Federal Reserve Banks 2. Board of Governors of the FED 3. Federal Open Market Committee (FOMC) 4. Federal Advisory Council 5. 2,000 member commercial banks

Advantages for the central bank being independent

1. If a central bank is subjected to political pressures, then it would cause an inflationary bias to the monetary policy (inflation rate, etc.) Example - politicians might seek short-run solutions to problems such as high unemployment or high interest rates These policies might not be beneficial for the long-run (political pressures = bad) 2. Thus, a Federal Reserve under the control of Congress or the president will be more likely to pursue a policy of excessive money growth when interest rates are high. A politically insulated FED is more likely to be concerned with long-run objectives and more likely to defend a stable price level. 3. control of monetary policy is too important to be left to politicians 4. An independent Fed can pursue policies that are politically unpopular yet ultimately in the public interest.

Case against independence for the Central Bank

1. It's undemocratic to have a monetary policy controlled by an elite group (independent) responsible to no one 2. Would you advocate independence for the Join Chiefs or the IRS (chiefs of staff should determine the military budget) (should the IRS set tax policies with no oversight by the president or Congress)? 3. an independent Fed has not always used its freedom successfully 9in HIstory) The Fed failed miserably during the Great Depression, its independence didn't prevent from an over expansion monetary policy that caused rapid inflation in the economy 1960-1970 4. Independence might cause the central bank to pursue self-interest rather than public-interest

What convinced the public that they needed a central bank?

1. Nationwide bank panics on a regular basis (every 20 years) 2. Panic of 1907 was so severe that the public was convinced a central bank was needed (worldwide bank failures and substantial losses to depositors)

Three largest federal reserve banks

1. New York 2. Chicago 3. San Francisco These FED Reserve banks hold 50% of the assets (discount loans, securities, others). New York bank has around a quarter of those assets

What does the FOMC make with decisions?

1. Setting the policy interest rate = federal funds rate -> The interest rate on overnight loans from one bank to another The FOMC is often referred to as the Fed in the press

Predictions that stem from a bureaucratic behavior view.

1. The FED will fight vigorously to preserve its autonomy (allowing freedom for the Fed) Example = The Fed has continually counterattacked Congressional attempts to control its budget 2. The Fed will avoid conflict with powerful groups that might threaten the Fed's freedom. The Fed has been able to mobilize a lobby of bankers and business people to preserve its independence. 3. Federal Reserve will try to avoid conflict with powerful groups that might threaten to curtail its power. Fed may be slow to increase interest rates (wishes to avoid conflict with the president/Congress). 4. Fed gaining control of more banks (altruism, the Fed might do good things for the public to feel good about themselves)

How are Federal Reserve Banks involved in monetary policy?

1. Their directors establish the discount rate 2. They decide which banks can obtain discount loans from the Federal Reserve Bank 3. Their directors select one commercial banker from each bank's district to serve on the Federal Advisory Council 4. Clear checks 5. Issue new currency Pg. 297

How independent is the FED? Two types of independence of central banks

1. instrument independence 2. goal independence Set by Stanley Fisher (vice-chair of the Federal Reserve)

Things that central banks affect in the economy

1. interest rates 2. amount of credit available 3. money supply affects financial markets, aggregate output, and inflation

Currently, about a ____ of the commercial banks in the US are members of the Federal Reserve System

1/3

Each of the _____ Federal Reserve districts defined by the Federal Reserve Act of 1913 has ___ main Federal Reserve Bank (Which may have branches in other cities in the district)

12 1

Term for Board of Governors

14 year term for members Not renewable - eliminating the incentive for the governors to carry favor the favor with the president and Congress

When was the Federal Reserve System created

1913

The directors of a district bank are classified into three categories

A,B,C A = are professional bankers (elected by member banks) B = Prominent leaders from industry, labor, agriculture C = appointed by the Board of Governors, are not allowed to be officers, employees, or stockholders of banks

Federal Reserve Act of 1913

Created the Federal Reserve System with twelve regional Federal Reserve Banks

Dodd-Frank Act

Excluded the three class A directors from involvement in choosing the president of the bank A lot of the risky debt were given good ratings (AAA)

The focal point for policy-making in the Federal Reserve System

FOMC

True or False Countries with independent central banks are less likely to have high unemployment than countries with less-independent banks.

False Countries with independent central banks are no more likely to have high unemployment or greater output fluctuations than countries with less independent central banks. About the same based on many sources of empirical evidence from many countries

All national banks are required to be members of the ______________-

Federal Reserve System Commercial banks chartered by the states are not required to be members, but they can choose to join.

Why was the U.S. slow to adopt a central bank?

Mainly due to American politics of that time. 1. Fear of centralized power (checks and balances provisions of the Constitution) States wanted their rights to be "preserved" 2. American distrust of moneyed interests (First Bank of the United States was disbanded in 1811, and the second base was disbanded in 1836) Fear that Wall Street would manipulate such an institution (central bank) might gain too much power over the economy.

Summary of Fed advocates

People who like the Fed's policies = support for independence People who dislike its policies = less independent fed

Tightening Monetary Policy and Easing Monetary Policy

Policy tool the Fed has for controlling the money supply Tightening of monetary policy = rise in the federal funds rate Easing of monetary policy (lowering the federal funds rate)

Another source of how the FED is independent (revenue)

The FED has independent and substantial source of revenue from its holdings of securities, an from its loans to banks.

Instrument Independence

The ability of the central bank to set monetary policy instruments

Theory of Bureaucratic behavior

The objective of a bureaucracy is to maximize its own welfare (Just as a consumer's behavior is motivated by the desire to maximize personal welfare and a firm's behavior is motivated by the desire to maximize profits This theory suggests that an important factor affecting a central bank's behavior is its wish to increase its power and prestige.

What was the goal the writers of the Federal Reserve Act want?

To diffuse power along the private sector and the government , and among bankers, business people, and the public Essentially, not have one faction of the bank to gain too much power Such as Wall Street manipulating the institution to gain control over the economy

Political Business Cycle

expansionary policies are pursued to lower unemployment and interest rates

Because of this independence, The Federal Reserve is

free from political pressures that influence government agencies

Goal independence

the ability of the central bank to set the goals of monetary policy

Central Banks essentially are _______

the government authorities in charge of monetary policy