Central Banks: A Global Perspective

PART 4. CENTRAL BANKING AND THE CONDUCT OF MONETARY POLICY

Chapter 14. Central Banks: A Global Perspective

1. The Federal Reserve System was created in 1913 to lessen the frequency of bank panics. Because of public hostility to central banks and to the centralization of power in general, the Federal Reserve System was created with many checks and balances aimed at diffusing power.

2. The Federal Reserve System consists of twelve regional Federal Reserve Banks, around 2,000 member commercial banks, the Board of Governors of the Federal Reserve System, the Federal Open Market Committee (FOMC), and the Federal Advisory Council. Although on paper the Federal Reserve System appears to be decentralized, in practice it has come to function as

The case for an independent Federal Reserve rests on the view that curtailing the Fed's independence and subjecting it to more political pressures would impart an inflationary bias to monetary policy. An independent Fed can afford to take the long view and not respond to short-run problems, which would result in expansionary monetary policy and a political business cycle. The case against an independent Fed holds that it is undemocratic for monetary policy (so important to the public) to be controlled by an elite group that is not accountable to the public. An independent Fed also makes the coordination of monetary and fiscal policy difficult.

5. The theory of bureaucratic behavior suggests that one factor driving central banks' behavior might be their attempt to increase their power and prestige. This view explains many central bank actions, although central banks may also act in the public

The Money Supply Process

1. The three players in the money supply process are the central bank, banks (depository institutions), and depositors.

2. Four items in the Fed's balance sheet are essential to our understanding of the money supply process: the two liability items, currency in circulation and reserves, which together make up the monetary base, and the two asset items, securities and loans to financial institutions.

3. The Federal Reserve controls the monetary base through open market operations and extensions of loans to financial institutions, and has better control over the monetary base than over reserves. Although float and Treasury deposits with the Fed undergo substantial short-run fluctuations, which complicate control of the monetary base, they do not prevent the Fed from accurately controlling it.

4. A single bank can make loans up to the amount of its excess reserves, thereby creating an equal amount of deposits. The banking system can create a multiple expansion of deposits, because as each bank makes a loan and creates deposits, the reserves find their way to another bank, which uses them to make loans and create additional deposits. In the simple model of multiple deposit creation, in which banks do not hold on to excess reserves and the public holds no currency, the multiple increase in checkable deposits (simple deposit multiplier) equals the reciprocal of the required reserve