1/3. The United States was one of the last major industrialized nations to form a Central Bank because of distrust in a central government agency. One can see this throughout the history of efforts to create the Central Bank (First Bank, Second Bank, and finally the National Bank). This is also why the Federal Reserve Bank System set up twelve Regional Banks rather than having only one. The First Bank of the United States was created to fix the debt caused by the Revolutionary war. Although the original intent of the First Bank was to finance the government, Alexander Hamilton decided to make it a commercial bank as well, meaning a for-profit bank. Although this allowed Hamilton to loan money to business owners, many argued this idea was unconstitutional as it allowed a private institution the power to tax and print money.
Therefore, in 1811, having “taken care of the national debt,” Congress refused to renew the Bank’s charter (by one vote), causing it to shut down. After just 5 years, due to the War of 1812, the national debt began to accumulate once again, and the Congress saw another need for a national bank. Acting as a regulator for state-chartered banks and a whole lot bigger in size (35 million dollar capital compared to the First Bank’s 10 million), the Second Bank was established in 1816. The main reason for the downfall of the Second Bank was primarily the cause of President Andrew Jackson. Since the beginning, Jackson announced his opposition to the bank and eventually the banks chartered having not being renewed, expired in 1836. Up until the Civil War, United States ran on what is commonly called the free banking system.
This allowed state-chartered banks to print their own money and have minimum regulation on their loans. Due to the debt caused by the Civil War, United States was forced to renew the idea of a national bank. The new policy allowed banks to choose between being nationally chartered or state-chartered. In 1865, state notes were taxed out of existence resulting in the first national currency. Finally, the Federal Reserve act of 1913 can be deciding date for the formation of the Central Bank.
The president at the time, Wilson, appointed two people, Carter Glass and Parker Willis, to create a proposal for the new banking system. After tremendous debate from December 1912 to December 1913, President Woodrow Wilson signed the Federal Reserve Act into law, creating a “decentralized central bank.” Therefore, one can argue because of the long-standing tradition of distrust of centralized power, it took a long time to set up a equal way of spreading power. In conclusion the Fed was spread across regional banks to prevent power from being concentrated in one location or by one interest group.
2. If the Reserve Requirements at the USA’s Federal Reserve Bank were eliminated, the size of the Money Market Mutual Funds would surely increase. Eliminating the Reserve Requirements would directly increase the amount of money supply. By increasing the money supply, there can be better opportunities of other investments, such as those offered by the Money Market Mutual Funds. Overall, the size of the whole market increases. One can also compare the Fed with Money Market Mutual Funds as different brand names. For example, imagine the Fed was Nike and Money Market Mutual Funds was Adidas. Taking money out of the safe from Nike would in turn eliminate the whole company, which would then lead to investors investing in Adidas. Or, if not eliminating the whole company, taking money from Nike would lead to more money in the market allowing more money to be spent on Adidas.
4. The structure of the Federal Reserve was carefully designed to incorporate the concepts of checks and balances. Its decentralized system and range of board members eliminates the chances of any one group having too much control. Each of the Federal Reserve’s tools (discount rate, OMO, or reserve requirements) is under the authority of a different group within the system.
For example, the Board of Governors has the authority to change bank reserve requirements, the boards of directors for the individual Reserve Banks can initiate changes to the discount rate (which then has to be approved by the Board of Governors), and the open market operations (the most important tool) is controlled by the FOMC, which represents both groups. These checks and balances structure of the Federal Reserve, make sure that partisan interests don’t have too much control and ensure that the Fed’s decisions represent the interests and needs of all citizens.
5/6. The Twelve Regional Federal Reserve Banks can influence the conduct of Monetary Policy in three major ways: Discount Rate, Reserve Requirements, and Open Market Operations.
a) Discount Rate- Discount Rate may be the primary tool the Federal Reserve influence the conduct of Monetary Policy. The word discount should not be mistaken as the common definition of marking down prices. In fact, discount rate, defines the short-term INTREST rate for loans by the Central Bank. The main objective of the discount rate is to meet temporary shortages of liquidity, usually on a short term basis. This dates back to the “Free Banking Era” when banks would literally offer money at a “discount” rate. One can see that using the Discount Rate, the Central Bank acts a lot like a regular commercial-bank, as it acts as The Bank for banks.
The Discount Rate is set up by the Board of directors for individual reserve banks. b) Reserve Requirements- This is another way the Central Bank regulates/influence the conduct of Monetary Policy. Basically, the Central Bank sets a minimum reserve at which each commercial bank must hold. Currently, the reserve requirements in the United States is 10% on transaction deposits. Altering the reserve requirements can be argued to directly influencing liquidity, especially for banks with low excess reserves. This reserve requirement is also set by the Board of Governors. c) Open Market Operations (OMO)- OMO is another way the central bank implements monetary policy.
Its main activity is caused by the central bank selling or buying government bonds to an open market. Usually, the goal of the OMO is to control the short-term interest rate (discount rate) and the supply of base money (reserve). In order to maintain a stable short-term interest rate, the OMO buys/sells in the open market when it has to. When there is a demand for base money, the Central Bank buys financial assets from an open market. To pay for these assets, money is printed and credited to the seller’s account, in return adding to the total amount of base money. More specifically, a committee known as the Federal Open Market Committee (FOMC) controls the OMO.
7/9. Anyone with a 14-year term, especially one that is non-renewable, will automatically feel insulated from political pressure. There are both positive and negative effects to this policy. On the brighter side, board members will not have to focus their time on reelection and will have more free time doing their job. On the other hand, board members could just do the bare minimum, knowing they are not eligible for reelection anyways. In my opinion, the second is the case. In fact, this 14-year non-renewable term for board members can arguably be the primary difference between the Federal Reserve Bank and other U.S. government agencies (as most government agencies include shorter terms as well as election from the public).
Once a governor is in place, he/she can make decisions that may not agree with the Executive and Legislative branch, and in lack of better words, get away with it. Also, the presidents of each Federal Reserve Bank are elected by member banks in each region. Therefore, the Board of Governors is almost immune to political pressure, except in a few ways, which is discussed later in Answer #10.
8. There are a few ways the ECB and the Fed are different in structure. First, the budgets for the regional banks in the Fed are established by the Board of Governors, while the national central banks in Europe are the ones who finance the Executive Board. Second, while majority voting in the 12-member FOMC goes to the seven-member Board of Governors, while the 15 national central banks in the ECB collectively have a majority in the Governing Council. Finally, the ECB is less involved in the supervision and regulation of financial institutions than the Fed is.
As far as independency goes, the Fed has more goal independence while the ECB is more politically independent. The Fed is free to pursue both low unemployment and low inflation, while the ECB is required to ensure price stability. However, the ECB is at less risk to political pressure because any change in the ECB’s structure or management would require a unanimous change to the Maastricht Treaty by all signatories (highly unlikely) whereas
a change to the Fed’s organization and structure could be passed by a simple majority in Congress (which leads to the discussion of the primary tool U.S. Congress uses to exercise its control).
10. Congress has the implied threat of taking over the Fed’s budget. Currently, the Fed earns enough from its discount lending to finance its entire operations and even has money left over (which it returns to the Treasury). However, Congress could force the Fed operations to be financed out of the national budget. If Congress were able to control this, they would be able to exert a great deal of control over monetary policy. Overall, simply threatening to take over the Fed’s finances may be enough to alter monetary policy.