Monetary Policy and Central Banks Goals

Study Notes

Main current goal of all Central Banks is price stability.
Price stability means low and stable inflation.
Benefits of price stability:
- Improves transparency of relative prices for firms, consumers and governments.
- 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.
Long-term economic growth is negatively affected by high inflation, especially in countries experiencing hyperinflation.
- Hyperinflation occurs when the monthly inflation rate exceeds 50%.

High employment or low unemployment, consistent with the natural rate of unemployment.
Output stability
Economic growth in the long-run.
Stability of financial markets
Interest-rate stability
Foreign-exchange market stability
Nominal anchors help to stabilize inflation expectations and prevent time-inconsistency problems.
- Examples of nominal anchors: the exchange rate, monetary aggregates, and the inflation rate.

The Monetary Policy Committee (MPC) is the main decision-making body.
- The MPC meets monthly and consists of 9 members.
- Decisions on monetary policy are made by voting.

Consists of 12 Federal Reserve Banks (FRB), Board of Governors (BG) and Federal Open Market Committee (FOMC).

Quasi-public institutions owned by private commercial banks in the district that are members of the Fed system.
Functions of the Federal Reserve Banks:
- Hold deposits for banks in their districts.
- Administer and make loans to banks in their districts.

12 members: 7 members of the Board of Governors + 5 presidents of the Federal Reserve Banks, including the president of the New York Fed.
Functions of the Federal Open Market Committee:
- Directs open market operations, buying and selling government securities to influence the money supply.
- Sets the federal funds rate, target rate for banks to charge each other.
- Monitors the economy and sets monetary policy.

The ESCB consists of the European Central Bank (ECB) and 27 National Central Banks (NCB).
Eurosystem: ECB + 20 NCB of the euro-area member countries.

Executive Board (EB): 6 members responsible for the day-to-day management and implementation of the Governing Council’s decisions.
Governing Council (GC): 6 EB members + 20 NCB governors, responsible for decision-making on monetary policy.

26 members: 6 EB members + 20 NCB governors.
Meets every second week at the ECB in Frankfurt.
Decides on key interest rates, reserve requirements, provision of liquidity to the banking system.
Operates by consensus.
Operates on a rotating system of votes.

Implement monetary policy set by the Governing Council of the ESCB.
Ensure settlement of domestic and cross-border payments.
Issue and handle euro notes.
Collect national statistical data and perform research.
Depending on national laws, NCB may be involved in banking supervision and regulation.

The Global Financial Crisis of 2007-2008 and the European Sovereign Debt Crisis (2010-2015) led to an expanding role of the ECB in banking policy.

Single Supervisory Mechanism (SSM, 2014): ECB oversees all significant banks in the euro area.
Single Resolution Mechanism (SRM, 2016): Procedures for restructuring or winding down banks whilst avoiding calls on the public purse.
European Deposit Insurance Scheme (EDIS, proposed in 2015 but not yet active): proposed to protect depositors from bank failures.

Widened mandate clashes with lack of direct democratic control and accountability.
Credibility, i.e. perception of independence, of central banks may suffer.
Risk of inconsistent policies.
Potential conflict with other elements of the mandate, such as financial stability.