1. Chapter 14: Central Bank Form and Function
Chapter Objectives
Define central bank and explain the importance of central banking.
Briefly sketch the history of U.S. central banking.
Explain when and how a country can do without a central bank.
Briefly sketch the structure of the Federal Reserve System.
Explain how other central banks compare to the Fed.
Define central bank independence and explain its importance.
Explain why independent central bankers prefer lower inflation rates than government officials do.

2. 1. America’s Central Banks
Roles of a Central Bank
A central bank is a bank under some degree of government control that is generally charged with:
Controlling the money supply (to a greater or lesser degree)
Providing price stability (influencing the price level)
Attaining economic output and employment goals
Regulating commercial banks (and perhaps other depository and non-depository financial institutions)
Stabilizing the macroeconomy (proactively and/or by acting as a lender of last resort during financial crises)
Providing a payments system (check clearing and long distance payments)
Holding deposits and making payments for the national government

3. 1. America’s Central Banks
In U.S. history
Bank of the U.S.
Regulated commercial banks and reserves, money supply; lender of last resort.
Independence and regulatory power led to its charter not being renewed.
Second Bank of the U.S.
No central bank
Roles of government’s banker and clearinghouse  private sector
Roles of bank regulation  state governments and markets
Role of managing the money supply  trade with fixed currency rates (commodity money tied to gold)
1914-present Federal Reserve

4. 1. America’s Central Banks
In General
No need for central bank if:
Fixed exchange rate currency  trade controls money supply
Use another currency  outsource monetary policy
Clearing done by  private sector
Regulation done by  market, other government institution
Lender of last resort  private wealth

5. 1. America’s Central Banks
In U.S. history
No central bank
Roles of government’s banker and clearinghouse  private sector.
Roles of bank regulation  state governments and markets.
Role of managing the money supply  trade with fixed currency rates (commodity money tied to gold)
Problems:
No official system-wide lender of last resort
Nobody to increase the money supply or lower interest rates in response to a shock

6. 1. America’s Central Banks
In U.S. history
1907 Panic. Private wealth (Morgan) as lender of last resort; fear of “money trust”
1913 Federal Reserve Act establishes Federal Reserve System

7. 12 Districts 2. The Federal Reserve System’s Structure
Boston (1)
New York (2)
Philadelphia (3)
Cleveland (4)
Richmond (5)
Atlanta (6)
Chicago (7)
St. Louis (8)
Minneapolis (9)
Kansas City (10)
Dallas (11)
San Francisco (12)
The Federal Reserve is composed of twelve numbered districts, each with its own Federal Reserve Bank

8. Owned (but not entirely controlled) by members in each district
2. The Federal Reserve System’s Structure
Owned (but not entirely controlled) by members in each district
All nationally chartered commercial banks and any state banks which choose to join
Members elect six district bank directors
three professional bankers and
three nonbank business leaders
Three directors appointed by The Board of Governors (Washington)
The nine directors, with the consent of the Board, then appoint a president.

9. Roles of the District Banks
2. The Federal Reserve System’s Structure
Roles of the District Banks
Issue new Federal Reserve Notes (FRNs) in place of worn currency
Clear checks
Lend to banks within their districts
Act as a liaison between the Fed and the business community
Collect data on regional business and economic conditions
Conduct monetary policy research
Evaluate bank merger and new activities applications
Examine bank holding companies and state-chartered member banks

10. Roles of the Federal Reserve Bank of New York
2. The Federal Reserve System’s Structure
Roles of the Federal Reserve Bank of New York
Conducts “open market operations” – buying/selling government bonds
Is a member of the Bank for International Settlements (BIS)
Safeguards over $100 billion in gold owned by the world’s major central banks
The FRBNY’s president is the only permanent member of the Federal Open Market Committee (FOMC)

11. Roles of the Federal Open Market Committee
2. The Federal Reserve System’s Structure
Roles of the Federal Open Market Committee
Decides on monetary policy – growth of money supply
Fed funds target rate
Discount rate at which district banks lend directly to member banks
Reserve requirements

12. 2. The Federal Reserve System’s Structure
The Board of Governors
7 Governors
Appointed by the president of the United States and confirmed by the U.S. Senate
Come from different Federal Reserve districts
Serve a single 14-year term
Chairperson is selected from among the governors and serves a four-year, renewable term

13. The Roles of the Fed’s economists*
2. The Federal Reserve System’s Structure
The Roles of the Fed’s economists*
Provide the chairman and the FOMC with:
new data
qualitative assessment of economic trends
quantitative output from the latest macroeconomic models
Examine the global economy
Analyze the foreign exchange market
Screen for possible shocks from abroad
Help the district banks to:
investigate market and competition conditions
engage in educational and other public outreach programs

14. The Roles of the Fed’s Chair
2. The Federal Reserve System’s Structure
The Roles of the Fed’s Chair
Influences the money supply or a key interest rate
Effectively controls reserve requirements and the discount rate
Is the Fed’s public face
Is its major liaison to the national government

15. Executive Board (Board of Governors)
3. Other Important Central Banks
Eurosystem structure (U.S. equivalent)
Chair
Executive Board (Board of Governors)
National Central Banks (Districts)
Governing Council (FOMC)

16. 3. Other Important Central Banks
The Bank of England
1694 Royal Charter granted by the Tonnage Act
Founded as a private corporation to be the banker for the British government
1946 became a state-owned institution

17. 4. Central Bank Independence
Factors of Independence
Rule of law
Control of Budget
Established by law or treaty
Appointed officials
Long terms of office
Non-renewable terms of office

18. Tougher on Inflation? Central Banks Elected government
4. Central Bank Independence
Tougher on Inflation?
Central Banks
Central banks represent banks and business
Inflation hurts net creditors
Inflation increases interest rate risk
Inflation creates uncertainty
Inflation slows investment
Inflation slows growth
Elected government
Politicians represent net debtors
Higher interest rates that combat inflation will cost them money and perhaps their job
Fiscal or monetary stimulus encourages growth