Federal Reserve System

Americans long resisted a central bank

Fear of centralized power

Distrust of moneyed interests

First U.S. experiments with a central bank

terminated in 1811 and in 1836

Without lender of last resort

Nationwide bank panics on a regular basis
Panic of 1907 JP Morgan to the rescue?
a central bank needed

Federal Reserve Act of 1913

Elaborate system of checks and balances

Decentralized
District banks: Quasi-public institutions owned by private
member commercial banks in the district

Goals of Central Banks

Price stability
High employment
Steady growth
Financial market stability
Stable interest rates
Stable exchange rate

} dual mandate of Fed

Price stability has long-run
precedence, consistent with
high employment

Time Inconsistency Problem: temptation to go beyond stated target

Hype the economy/lose credibility
Worker and firm altered expectations and responses undo policy intent
Rules not discretion
Taylor Rule: Violate it at your risk!
But Governor Mishkins pragmatism
Bagehots rule: Lend and lend freely
Keynes: In the long-run were all dead

Time
Inconsistency:
An Example

The Functions of a Modern Central Bank

The Government's Bank:
Manages government transactions.

Controls availability of money and credit.

The Bankers Bank:
Lender of last resort in crises
Operates clearing system for
payments.
Oversees financial intermediaries
- ensure their soundness.
- ensure public confidence

interbank

Functions of Federal Reserve District Banks

Clear checks

Issue new currency/withdraw damaged currency

Make discount loans to banks in district
Evaluate mergers/expansions of bank activities
Liaison between business community and the Fed
Examine bank holding companies and state-chartered member
banks
Collect data on local business conditions
Research Money, Banking and the Financial System

FRBNYs special roles

Bond and currency open market operations
Supervise bank holding companies in NY district
Member of Bank for International Settlements

Board of Governors

Seven members headquartered in D.C.

Appointed by president/confirmed by Senate

14-year non-renewable term

Chairman serves 4-year renewable term

Chairman speaks for Fed/Runs the Show

Set reserve requirements

Control the discount rate

Direct open market operations

Approve bank mergers
Regulate bank holding companies/foreign banks in
the US

Federal Open Market Committee(FOMC)

Meets eight times a year more often if needed

Reports on domestic and currency open market operations

Green book forecast

Blue book forecasts responses to alternative policies

12 Voting members: 7 Fed Governors; president of

FRBNY; and presidents of 4 other district banks in
rotation
BoG Chairman chairs FOMC
End of meeting announcements:

Directive to the trading desk at FRBNY

Balance of risks statement

small events at times have large

consequences. A liquidity crisis in a
fractional reserve banking system is
precisely the kind of event that can
trigger and often has triggered a chain
reaction. And economic collapse often has
the character of a cumulative process. Let
it go beyond a certain point, and it will
tend for a time to gain strength from its
own development as its effects spread and
return to intensify the process of collapse.
Because no great strength would be
required to hold back the rock that starts
a landslide, it does not follow that the
landslide will not be of major proportions.

How Independent is the Fed?

Instrument independent
Goal independent undemocratic?

Political pressure would impart inflationary bias to monetary policy

Political business cycle?

Could facilitate Treasury financing of large budget deficits
accommodation

Independent revenue
Structured by Congress/accountable to Congress

Presidential influence

Influence on Congress
Appoints members
Appoints chairman

European Central Bank

Patterned after the Federal Reserve
Central banks from each country play similar role
as Fed district banks

Monetary operations are not centralized

ECB does not supervise and regulate financial

institutions

More independent than Fed

Maastricht Treaty would have to be revised to
change ECB charge

But less goal independent than Fed

Price Stability Rules