Chapter 16 Central Banks and the Federal Reserve System I Price Stability and the Nominal Anchor a Price Stability which central bankers define as low and sable inflation i Rising and unexpected inflation can lead to not being able to predict prices and high inflation that can reduce spending Inflation leads to lower economic growth ii b Nominal Anchor a nominal variable such as inflation rate or the money supply whoich ties down the price level to achieve price stabillty i Can reduce Time Consistency Probplems 1 Whee Monetary policy is conducted on a day to day level a Leads to bad long run economic growth II Other Goals of Monetary Policy a High Employment supply of labor i Natural Rate of Unemployment demand for labor equals the 1 Will never be equal to 0 because of people that are frictionally unemployed and structurally unemployed b Economic Growth i Busibesses are more likely to invest in capital projects when when unemployment is low ii Provide Tax incentives for people to invest iii Supply Side Economic Growth iv Save money for Tax ayers c Stability of Financial Markets i Helps create a sense of stability in markets and a sense of confidence d Interest Rate Stability i Fluctuations in interest rate can create uncertanies on the ii future of interest rates Increase in interest rates create a large capital loss for long term bonds and mortgages 1 Can cause financial institutions holding them to fail e Stability in the foreign exchange markets i Rise in the value if the dollar makes American Business less ii Decline in the value if the dollar makes industry more competitive competitive III Should Price Stability be thesole Monetry Policy Goal 1 Stimulates inflation a There is NO long term trade off between unemployment and Inflation b Hierarchial Mandate rates that as long as it is achieved other goals can be pursued putthe goal of price stability first and then say c Dual Mandate price stability and maximum unemployment i USA d Either policy is acceptable as long as it looks to make price stability the primary goal in the long run IV Structure of the Federal Reserve System a See page 388 b Federal Reserve BanksEach of the 12 districts has one Main Federal Reserve Banks i May be branches in other cities in district ii E Fed bank is Quasi Public Part government and part private 1 Appont people to run branch iii Functions iv Effect On Monetary Policy Issue new currency 1 Clear checks 2 3 Withdraw damage currency from circulation 4 Administer and make discount loans to bnks in district 5 Evalueate proposed mergers of banks 6 Liasons between business community and Fed 7 Examine bank holding companies and state chartered banks 8 Collect data on local bi usiness operations 9 Research monetary policy 1 Directors establish discount rate a Reviewed by the board of governors 2 Decide which banks can receive loans from Fed 3 Directors select one commercial banker from each dirstrict tp serve on Fed adviserory board a Consults with board of governors 4 5 fof the 12 presidents have a vote on the federal open markets operations a effect purchase and sale of government securities that effect the interest rates and amount of reserve in systems c Member Banks i All National banks chartered by office of comptroller of the currency are reuired to be member of the Fed ii Banks not part of system can keep reserve requirements in line with the state not with the Fed regulations 1 Were able to keep reserve in interest baring securities as opposed to the Fed which didn t pay interest a Costly to be a member of the Fed d The Board of Governors of the Federal Reserve system i board of Governor s appointed by President and confirmed by Senate 1 14 year term and part of a second term 2 come from different federal reserve districts 3 Chairman is choosen by president for a 4 year term 4 All 7 governors embers of FOMC a Vote on conduct of open market b Sets reserve requiremtns c Sets discount rate d Sets salary of president e Sets margin requiremnts of securities f Approves bank mergers e Federal Open Markets Commotteee i Meets about every 6 weeks ii Meet about open market operations which influence the money supply and interest rate iii Media often says that the Fed Is meeting when they meet a V Fed s Independence Instrument Independence monetary policy instruments b Goal Independence monetary policy the ability of the central bank to set the ability of the central banks to set the goals of c Fed is relatively independent from the President and Congress because of the 14 year sentence VI European Central Bank a Differences from Fed i Control their own budgets versus from the board of governors ii Monetary policies are realized by each country since the ECB has no control over monetary policy over Europe only each country does iii Does not regulate financial institutions this is done by regulatory agency in each company b Governing Council VII Other Foreign Banks a Canada b England i Not that independent i Not that independent c Japan i Independent d Trend os to become more independent e