The Federal Reserve (1913) - Laramie, · PDF fileThe Federal Reserve (1913) • Original...
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The Federal Reserve (1913)The Federal Reserve (1913)
• Original RolesOriginal Roles-- Provider of Discount Window --
“L d f L R ”“Lender of Last Resort”-- Regulate Member Banks
(e.g. Reserve Ratios)• Manages Monetary PolicyManages Monetary Policy
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Structure of the Federal ReserveStructure of the Federal Reserve
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Board of Governors (BOG)
• 7 members• appointed by the President, with the
consent of the Senateconsent of the Senate• serve 14 year, non-renewable terms
t li i t t th th • sets policy instruments other than open market operations
• decides what banks can do
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• Important Chairs of the BOG • Important Chairs of the BOG (Federal Reserve)
• Paul Volcker -- 1979-87Paul Volcker 1979 87• Alan Greenspan -- 1987-2006• Ben Bernanke – 2006-
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The Federal Open Market C i (FOMC)Committee (FOMC)
• 12 voting members -- 7 Board of • 12 voting members -- 7 Board of Governors + 5 District Bank P id t (19 b )Presidents (19 members)
• meet 8 times per year (or more)p y ( )• design monetary policy, by
specifying Federal Funds rate target specifying Federal Funds rate target (since 1988)
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Federal Reserve District BanksFederal Reserve District Banks
• each bank exists within 12 districts each bank exists within 12 districts within the US
• holds deposits of Federal Government• holds deposits of Federal Government• collects economic data and does
i heconomic research• issues and discards currency• performs check clearing services
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District Banks -- Administer M P liMonetary Policy
• conduct Discount Loans with banks conduct Discount Loans with banks within district
• enforce reserve requirements for banks • enforce reserve requirements for banks within districth ld f b k ithi di t i t• hold reserves of banks within district
• New York bank most important, open market operations done there
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Federal Reserve Branch Banks and M b B kMember Banks
• Branch (District) Banks -- serve as • Branch (District) Banks -- serve as decentralized regulators, primarily f l F d di t i t i hi for larger Fed districts in geographic size
• Private Banks -- membership distinction trivialized by DIDMCAdistinction trivialized by DIDMCA
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How Independent is The Federal R ?Reserve?
• Structure implies considerable • Structure implies considerable independence.
• Federal Reserve is financially independent of the Federal pGovernment’s budget.
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• Federal Reserve is still subject to Congressional legislation.g g-- House Concurrent Resolution
133 -- Fed must announce itspolicy objectives for moneygrowth.
-- Humphrey-Hawkins Bill -- Fedmust testify to Congress how itsobjectives are consistent withthe President.
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• The President and the Federal Reserve-- President appoints members of
the BOG-- BOG typically serve less than 14
t year terms -- part of the legislative process,
can introduce legislation
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• Federal Reserve has vigorous lobby • Federal Reserve has vigorous lobby in Congress.-- banks: stability of banking
systemsystem-- financial markets: low inflation,
stability -- international presenceinternational presence
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Explaining Federal Reserve B h i Behavior
• Theory of Bureaucratic Behavior --• Theory of Bureaucratic Behavior --The objective of a bureaucracy is to
i i it lfmaximize its own welfare.
• Applied to the Federal Reserve --The Fed seeks to maximize its power The Fed seeks to maximize its power and autonomy.
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Evidence: The Fed and The Theory of Bureaucratic Behavior
• Fed avoids conflict with Congress.• Fed does not admit policy mistakes (e g Fed does not admit policy mistakes (e.g.
“Base Drift)F d t l i l ti th t i • Fed supports legislation that increases its authority (DIDMCA, FDICIA)
• Fed has not seen any of its powers removed.
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Should the Federal Reserve Remain Independent?Remain Independent?
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Arguments to Remove Independence Remove Independence
• Current Federal Reserve is not democratic, not accountable.
d h d l k• Fed has made policy mistakes.• Potential for uncoordinated fiscal and
t li imonetary policies• Example -- expansionary fiscal policy
with contractionary monetary policy ⇒with contractionary monetary policy ⇒Interest rates↑
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Arguments to Maintain Independence Maintain Independence
• If part of the Federal Government, the Federal Reserve could be used to purchase all of the Federal deficit and debt (“monetizing the debt), highly i fl ti inflationary.
• Federal Reserve is more knowledgeable d f d h hand focused on the economy than
Congress.
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The Biggest Argument For Continued Independence Continued Independence
• Current Federal Reserve can make the tough policy decisions.the tough policy decisions.
• The track record of the US Federal Reserve
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Ben Bernanke at the Federal Reserve: What Can We Expect?
Henning BohnProfessor of Economics
UC Santa Barbara
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Ben Bernanke at the Federal ReserveWhat Can we expect?
1. Who is Ben Bernanke?Personality matters. Fed Policy is run by committee.
2. Bernanke’s approach to monetary policy.• Foundations: New Keynesian macro theory.• His signature proposal: Inflation targeting.• His views on asset prices, world savings, a/o key issues.
3. Challenges: Dealing with the Unexpected.• Setting Interest Rates - the Fed Funds target. • The Slowdown in Real Estate: How will the Fed respond? • Potential problems: The Dollar. Bank lending.
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Who is Ben Bernanke?A personal perspective.
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Ben Bernanke’s Monetary Policy
• How will he run the Federal Reserve?Easy to answer: Read his writings!– On New Keynesian macroeconomic theory.– On inflation targeting.– On many other issues - usually find a publication.
• Do the academic writings matter? – Yes, for credibility. And in New Keynesian theory
Credibility is crucial.
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Perspectives on Monetary Policy (1):
New Keynesian Macro Theory
1. Inflation is economically harmful. Fed’s top priority: keep inflation low and stable.
2. Money affects real output and employment.• There is a short run trade-off between stable employment
and stable prices; a.k.a. the “Phillips curve”.Fed must be sensitive to business cycles.
3. Households/firms respond to expected inflation. • If low inflation is expected, the Fed can more easily
respond to cycles & keep interest rates more stable. Fed must maintain credibility (that inflation will stay low).
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Perspectives on Monetary Policy (2):
Inflation Targeting• Bernanke’s proposal on how the Fed should operate.
– Detailed in a Princeton Univ. book:“Inflation Targeting: Lessons from the International Experience.”
– Message: A specific target helps stabilize inflation at low “cost”.• Will the Fed adopt an official inflation target?
– Open question. Objections based on the Federal Reserve Act.– All Fed governors have an informal target. Growing support.
Newest Fed Gov. Mishkin is a coauthor of Inflation Targeting.
• What exactly is the target? Several measures of inflation:CPI (consumer price index) or PCE (personal consumption expend. deflator)? Headline (all items) or Core (excluding food & energy)?Answer: Core PCE. Ben’s comfort zone: 1-2% growth.
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Recent Inflation DataCore CPI: +2.6% (Dec.06). Up 0.1%.Core PCE: +2.2% (Dec.06). Constant.
2.6%2.2%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
Jan-
00
Jul-0
0
Jan-
01
Jul-0
1
Jan-
02
Jul-0
2
Jan-
03
Jul-0
3
Jan-
04
Jul-0
4
Jan-
05
Jul-0
5
Jan-
06
Jul-0
6
Jan-
07
CPI-core CPI-all PCE-core PCE-all 2%-bound
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Perspectives on Monetary Policy (3):
Key Non-monetary Issues
Clues how Bernanke would respond to economic problems• Asset prices:
– Ignore bubbles and crashes, but do respond to the effects on inflation and employment.
– Recognize the Fed’s crisis-management responsibility.
• The U.S. current account deficit:– Driven primarily by a “glut” of world savings.
• Fiscal policy: – Preference for the Fed to stay silent.
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What Could Go Wrong?
• The real challenge: Dealing with the Unexpected!How would the Bernanke Fed respond?
• The “Slowdown” in Real Estate– No direct response [unless it triggers a banking crisis or mass unemployment]
– Problem: Core-PCE includes rental cost! Rising > 3%.
• Potential for bank lending problems [if beyond sub-prime]
– Recognize the ‘Credit Channel’ - respond to employment effects.– Worst case: Fed will serve as ‘Lender of Last Resort.’
• Potential for a U.S. dollar/current account crisis – Benign view of imbalances - inclined to let the markets work. – Key Issues: Rising import prices vs. employment effects.
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Conclude: What Can We Expect? 5.25% Fed Funds rate target - “Paused, with Upward Bias”
Federal Reserve Projections(Percentage changes - 4th quarter to 4th quarter.)
2.75-3.02.5-3.03.4Real GDP
4.5-4.754.5-4.754.5Unempl. Rate
1.75-2.02.0-2.252.3InflationCore PCE
Expect 2008
Expect 2007
Actual 2006
Key Data
The Fed Funds Rate
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Perc
enta
ge
Poin
ts