Chapter 13: Central Banks and the Federal Reserve System

Question 1

Origins of the Federal Reserve System

Answer 1

1) Resistance to establishment of a central bank
2) No lender of last resort
3) Federal Reserve Act of 1913 (elaborate system of checks and balances; decentralized)

Question 2

Structure of the Federal Reserve System Figure 1

Answer 2

Writers wanted to diffuse power; includes the following entities:

• The Federal Reserve banks
• The Board of Governors of the Fed
• The Federal Open Market Committee (FOMC)
• The Federal Advisory Council
• Around 2,900 member commercial banks

Question 3

Board of Governors

Answer 3

• Seven members, including the chairman (4 yr), appointed by the President of the US and confirmed by the Senate
• appoints 3 directors to each FRB
• headquartered in Washington D.C.
• 14-year non-renewable term

Question 4

Federal Reserve Banks (FRBs) (12)

Answer 4

• Quasi-public institution owned by private commercial banks in the district that are members of the Fed system
• Each with nine directors who appoint president and other officers of the FRB

Question 5

Member banks

Answer 5

Around 2,500 member commercial banks; elect six directors to each FRB

Question 6

Federal Open Market Committee (FOMC)

Answer 6

• Seven members of Board of Governors plus presidents of FRB of New York and four other FRBs
• Same chair as the Board of Governors

Question 7

Federal Advisory Council

Answer 7

• Twelve members (bankers), one from each district
• All national banks required to be in the Fed
• Commercial banks chartered by states are not required but may choose to be members

Question 8

Functions of the Federal Reserve System (1-5)

Answer 8

1) Clear checks
2) Issue new currency
3) Withdraw damaged currency from circulation
4) Administer and make discount loans to banks in their districts
5) Evaluate proposed mergers and applications for banks to expand their activities

Question 9

Functions of the Federal Reserves System (6-9)

Answer 9

6) Act as liaisons between the business community and the Federal Reserve system
7) Examine bank holding companies and state-chartered member banks
8) Collect data on local business conditions
9) Use staffs of professional economists to research topics related to the conduct of monetary policy

Question 10

Fed banks and monetary policy

Answer 10

• Directors “establish” discount rate and decide which banks can obtain discount loans
• 5 of the 12 bank presidents have a vote in the FOMC

Question 11

Depository Institutions Deregulation and Monetary Control Act of 1980

Answer 11

Subjected all banks to the same reserve requirements as federal banks and gave all banks access to federal reserve facilities

Question 12

Duties of the Board of Governors (1-5)

Answer 12

1) Votes on conduct of open market operations
2) Sets reserve requirements
3) Controls the discount rate through “review and determination” process
4) Sets margin requirements
5) Sets salaries of President and officers of each fed bank ‘s budget

Question 13

Duties of the Board of Governors (6-8)

Answer 13

6) Approves bank mergers and applications for new activities
7) Specifies the permissible activities of bank holding companies
8) Supervises the activities of foreign banks operating in the U.S.

Question 14

Chairman of the Board of Governors

Answer 14

1) Advises the president on economic policy
2) Testifies in Congress
3) Speaks for the Federal Reserve System to the media
4) May represent the U.S. in negotiations with foreign governments on economic matters

Question 15

Why chairman of the board is really in charge

Answer 15

1) Spokesperson for the Fed and negotiates with Congress and the President
2) Sets the agenda for meetings
3) Speaks and votes first about monetary policy
4) Supervises professional economists and advisers

Question 16

How independent is the Fed?

Answer 16

1) Instrument and goal independence
2) Independent revenue
3) Fed’s structure is written by Congress, and is subject to change at any time
4) Presidential influence - influence on congress, appoints members, appoints chairman although terms are not concurrent

Question 17

The case for independence

Answer 17

1) Political pressure would impart an inflationary bias to monetary policy
2) Political business cycle
3) Could be used to facilitate Treasury financing of large budget deficits: accommodation
4) Too important to leave to politicians—the principal-agent problem is worse for politicians

Question 18

The case against independence

Answer 18

1) Undemocratic
2) Unaccountable
3) Difficult to coordinate fiscal and monetary policy
4) Has not used its independence successfully

Question 19

Theory of bureaucratic behavior

Answer 19

objective is to maximize its own welfare which is related to power and prestige

• Fight vigorously to preserve autonomy
• Avoid conflict with more powerful groups
• Does not rule out altruism

Question 20

Evolution of fed’s communication strategy

Answer 20

Dramatically increased its transparency in recent years

• press conferences to clarify monetary policy
• announcement of target inflation rate

Question 21

Differences between the European system and Fed

Answer 21

1) National Central Banks control their own budgets and the budget of the ECB
2) Monetary operations are not centralized
3) Does not supervise and regulate financial institutions
* ECB is the most independent in the world (members have long terms, determine own budget)