Untitled Quiz

Study Notes

Goals of Central Banks

Primary goal of central banks is price stability (low and stable inflation).
Benefits of price stability:
- Improves transparency of relative prices
- Reduces distortions of tax and social security systems
- Prevents arbitrary redistribution of wealth and income
- Reduces inflation risk premia in interest rates
- Avoids unnecessary hedging activities
- Increases benefits of holding cash
Empirical evidence suggests higher inflation leads to lower economic growth (particularly in hyperinflation countries)

Structure of Central Banks

Federal Reserve System (Fed)
- 12 Federal Reserve Banks (FRB) geographically spread across the US
- Structure helps influence local economic conditions
- Board of Governors (7 members) headquartered in Washington, D.C.
  - Appointed by U.S. president and confirmed by Senate
  - Serve 14-year non-renewable terms
  - Oversees operations of FRB, controls the budget
- Federal Open Market Committee (FOMC)
  - 12 members: 7 Board of Governors, president of NY Fed, 4 presidents of other FRB
  - Meets 8 times a year
  - Decides on interest rates and monetary policy
European Central Bank (ECB)
- Established in 1998 to manage monetary policy for the Euro
- Single responsibility for the euro area
- Euro system: the ECB + the national central banks of the euro area
- Governing Council: Decision-making body of the ECB
  - 25 members: 6 members of the Executive Board + 19 governors of the national central banks
  - Located in Frankfurt, Germany
Other Key Organizations
- Bank of England (BoE)
  - Central bank of the UK
  - Established in 1694
  - Responsible for monetary policy, financial stability, and banking supervision
  - Also acts as banker to the UK government
- European Banking Authority (EBA)
  - Established in 2011
  - Mandate: “furthering the single market for the EU banking sector”
  - Activities include preventing regulatory arbitrage, harmonising banking supervision, and performing stress tests on EU banks
Expanding Role of the ECB
- "Banking Union" with three pillars:
  - Single Supervisory Mechanism (SSM): Ensures consistent supervision of banks across the euro area
  - Single Resolution Mechanism (SRM): Predictable restructuring or winding down of banks without reliance on public funds
  - European Deposit Insurance Scheme (EDIS): Proposed, but not yet implemented, aims to provide a safety net for depositors in the event of local financial shocks
Key Objectives of Central Banks
- Price stability (main goal)
- High employment or low unemployment (consistent with the natural rate of unemployment)
- Economic growth
- Financial market stability
- Interest rate stability
- Foreign exchange market stability

Independence of Central Banks

Dimensions of Independence
- Instrument Independence: Ability to set monetary policy instruments freely
- Goal Independence: Ability to set monetary policy goals independently
- Financial Independence: Ability to manage own budget independently
- Political Independence: Ability to operate independently from political influence
Central Bank Examples
- BoE:
  - Some instrument independence, subject to government oversight in “extreme economic circumstances”
  - Inflation target set by the government
  - Financially independent
  - Governor appointed by Chancellor of the Exchequer
- Fed:
  - Instrument and goal independent
  - Financially independent
  - Politically independent through structure, but subject to presidential influence
- ECB:
  - Most instrument and goal independent central bank
  - Financially independent
  - Politically independent: not allowed to finance governments, cannot be instructed by political authorities