1. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main1 Lecture 7 DETERMINANTS OF THE MONEY SUPPLY, AND THE TOOLS OF CENTRAL BANKS (1)

2. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main2 European System of Central Banks

3. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main3 European System of Central Banks The European System of Central Banks (ESCB) consists of the European Central Bank (ECB) and the national central banks of the EU Member States. The activities of the ESCB are carried out in accordance with the Treaty establishing the European Community (Treaty) and the Statute of the European System of Central Banks and of the European Central Bank (ESCB/ECB Statute).

4. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main4 Governance of the ECB The ESCB is governed by the decision- making bodies of the ECB. –The Governing Council of the ECB is responsible for the formulation of monetary policy, –the Executive Board is empowered to implement monetary policy. The ECB has recourse to the national central banks to carry out her operations. The ESCB policy operations are executed on uniform terms and conditions in all Member States.

5. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main5 ESCB: Basic tasks The basic tasks by the Eurosystem are: –to define and implement the monetary policy of the euro area; –to conduct foreign exchange operations; –to hold and manage the official foreign reserves of the Member States; and –to promote the smooth operation of payment systems. In addition, the Eurosystem contributes to the prudential supervision of credit institutions and the stability of the financial system.

6. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main6 The US Federal Reserve System The formal structure of the Federal Reserve System is characterized by –a regional decentralization (there are 12 Federal Reserve Banks) –each Federal Reserve Bank is quasi-public (partly held by government, partly by commercial banks in the district). –all national banks chartered by the Office of the Comptroller of the Currency have to be members of the Federal Reserve System.

7. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main7 The Federal Reserve Bank of New York The Federal Reserve Bank of New York has a special role (through its involvement in the bond and foreign exchange markets and through the presence of large commercial banks). The FRBNY is the only US Reserve Bank to be a member of the Bank for International Settlements (BIS). Its president assumes a chief role in the system.

8. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main8 Governance of the Federal Reserve System The Fed is headed by a seven-member Board of Governors, with its influential Chairman (Alan Greespan), headquartered in Washington D.C. The Board of Governors is actively involved in monetary policy making. All governors are (voting) members of the Federal Open Market Committee (FOMC). In addition there are 12 (of whom 5 voting) members from district banks in the FOMC.

9. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main9 Should central banks be independent? A cornerstone of the monetary constitution of the euro area is the independence of the ECB and of the NCBs (Article 108). There are fears that a dependent ECB –could succumb to financing large budget deficits of the government. –could be asked to monetize too much debt, which would entails an inflationary bias. Central banking also requires expertise and “should not be left to politicians”.

10. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main10 Should central banks be independent? Counterarguments: –It is undemocratic to have monetary policy controlled by a non-elected elite group. –There is no accountability in central banking, which is a precondition for, and core element of, democratic legitimacy. –There is need to coordinate monetary and fiscal policies. –The ECB could pursue a policy of self- interest.

11. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main11 Principal-agent problem There is a typical principal-agent relation between the Legislature and an independent institution bestowed with a public function. In line with the requirements of Article 113 of the Treaty, the President of the ECB presents the ECB’s Annual Report to the European Parliament at its plenary session. This is followed by the adoption of a European Parliament resolution, which provides a comprehensive ex post assessment of the ECB’s activities and policy conduct. The Chairman of the Fed reports to the US Congress.

12. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main12 The objectives of the ESCB The primary objective of the ESCB, as defined in Article 105 of the Treaty, is to maintain price stability. Without prejudice to the primary objective, the ESCB has to support the general economic policies in the EU. In pursuing its objectives, the ESCB has to act in accordance with the principle of an open market economy with free competition, favoring an efficient allocation of resources.

13. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main13 The mandates of central banks

14. Paul Bernd Spahn, Goethe-Universität Frankfurt/Main14 Reporting requirements of central banks