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The European Central Bank and the Federal Reserve System - a general comparison

Term Paper 2010 16 Pages

Business economics - Banking, Stock Exchanges, Insurance, Accounting

Excerpt

Table of contents

List of figures

List of abbreviations

1 Introduction

2 Institutions and bodies
2.1 The European Central Bank
2.1.1 The Eurosystem and the European System of Central Banks
2.1.2 Decision-making bodies of the European Central Bank
2.2 The Federal Reserve System
2.2.1 Board of Governors
2.2.2 Federal Open Market Committee
2.2.3 Twelve Federal Reserve Banks

3 Tasks and objectives
3.1 Tasks and objectives of the European Central Bank
3.1.1 Price stability as the primary objective
3.1.2 Miscellaneous tasks of the European Central Bank
3.2 Tasks and objectives of the Federal Reserve System

4 Monetary policy instruments
4.1 Open market operations
4.1.1 Open market operations of the European Central Bank
4.1.1.1 Main refinancing operations 7a
4.1.1.2 Longer-term refinancing operations
4.1.1.3 Fine-tuning operations
4.1.1.4 Structural operations
4.1.2 Open market operations of the Federal Reserve System in comparison with the European Central Bank
4.2 Minimum reserve
4.2.1 General points
4.2.2 Minimum reserve policy of the European Central Bank
4.2.3 Minimum reserve Policy of the Federal Reserve System in comparison with the European Central Bank
4.3 Standing Facilities
4.4 Discount Policy

5 Monetary political actions during the crisis
5.1 Reactions of the Federal Reserve System
5.2 Reactions of the European Central Bank
5.3 Interest policy of the Federal Reserve System in comparison with the European Central Bank

6 Conclusion

Bibliography

List of figures:

Graph 1: Base rate developmet 2000-2010

List of abbreviations:

illustration not visible in this excerpt

1 Introduction

Since the foundation of the European currency union in 1998, the European Central Bank and the Federal Reserve System represent the most influential two central banks in the world. In this comparison their general structure, tasks and objectives and monetary policy instruments are contrasted. The institutions and bodies of the banks are explained in the second chapter, to see the structural differences. While the ECB defined price stability as its primary objective, the Fed has several equal objectives. These objectives and further tasks of the central banks are described in the third chapter. To steer and implement their objectives and tasks, the central banks have monetary policy instruments at disposal, whereas open market operations and the minimum reserve system play a key role. These instruments are explained in chapter 4 in general and their arrangement and implementation at the example of the ECB. Then the Feds corresponding instruments are contrasted with the ECB, because in my opinion the ECB has a role model position, in this context. Then follows an elaboration of the instruments standing facilities and discount policy. These instruments are examined in two separate subchapters, due to the fact that the implementation of these instruments is only made by the ECB or the Fed.

In the last part I examined the reactions of the ECB and the Fed to compensate the risks of the current financial crisis. The attention is directed to the evaluation of the quality and effectiveness of the implemented monetary policy instruments. At the end the results are summarized.

2 Institutions and Bodies

2.1 The European Central Bank

2.1.1 The Eurosystem and the European System of Central Banks (ESCB)

The European System of Central Banks (ESCB) consists of the legally autonomous National Central Banks of all EU member states, as well as the legally autonomous European Central Bank (ECB). The Eurosystem, however, consists of the 16 National Central Banks (NCB) of the countries, which belong to the Euro currency area, and the European Central Bank. The ECB is the heart of the Eurosystem and is responsible for compiling all the tasks of the Eurosystem itself or by the NCBs. The NCBs are thereby functionally subordinated to the ECB, and "are an integral part of the Eurosystem, which is responsible for price stability in the Euro area; they operate in line with the ECB’s guidelines and instructions in the performance of the Eurosystem’s tasks."1

2.1.2 Decision-making bodies of the European Central Bank

The ECB´s major decision-making body is the ECB Governing Council, which directs the Eurosystem. It consists of the presidents of the 16 National Central Banks, the president and vice-president of the ECB as well as four members of the ECB Executive Board. It usually holds a meeting every 14 days at the Eurotower in Frankfurt am Main, Germany.2 Every member of the Governing Council holds one vote. Decisions are made through majority of the members present. Responsible for the execution of monetary policies are the NCB`s, the presidents of which are nominated by the member states.3 The six-strong Executive Board leads the ECB. It consists of the president and the vice-president of the ECB as well as four additional members. The members are elected unanimously by the heads of state and government of the member states, upon the recommendation of the finance- and economy ministers. Their nomination lasts eight years and can not be extended.4 Since not all EU member states joined the currency union, the General Council also acts as an advisory body. Its primary function is the monetary political coordination, but it has no monetary political responsibility. The General Council leads the ESCB and is composed of the governors of the 27 NCB`s, the president and the vice- president of the ECB.5

2.2 The Federal Reserve System (Fed)

2.2.1 Board of Governors (BOG)

The Board of Govenors (BoG) consists of seven members, which are appointed by the President of the U.S. and has to be confirmed by the Senate. Their time in office amounts to fourteen years. A reelection is not possible. To ensure that individual Federal Reserve Districts are not over-represented, the members has to come from different districts. The Chairman as well as the Vice-Chairman of the BoG are nominated by the President out of the seven members of the BoG and confirmed by the Senate. Their time in office amounts to four years in each case and a reelection is possible. Every member of the BoG is also represented in the Federal Open Market Committee (FOMC).6

2.2.2 Federal Open Market Committee (FOMC)

The FOMC is responsible for the open market policy. It consists constantly of the seven members of the BoG and the president of the Federal Reserve Bank New York. The remaining four places are shared between the eleven Presidents of the FRB´s, with an annual shift, beginning January 1 each year. Every six weeks meetings take place, where the Presidents of all FRB`s also take part. They inform about the economical development in their district but have no voting right. The Chairman of the BoG is simultaneously chairman of the FOMC, because of the fact that the BoG owns the majority of votes in the FOMC.7

2.2.3 Twelve Federal Reserve Banks (FRB)

Each of the twelve Federal Reserve Banks (FRBs) is responsible for a certain district and defines the bank rate.8 The Federal Reserve Bank of New York plays a special role, since it is actively integrated into the share market (the majority of the most powerful banks of the USA have their headquarters in New York) and it has a constant place in the Bank for International Settlements (BIS).9 The president of each FRB is nominated by the nine directors of the member banks of the FRB with compliance of the BoG. The presidents time in office amounts to five years, whereas an reelection is possible. Six of the nine directors are nominated by the member banks, where by three have to be from the banking industry and three from the nonbanking industry. The remaining three directors are identified by the BoG. They are not permitted to work for a bank or hold shares of a bank.10

3 Tasks and Objectives

3.1 Tasks and Objectives of the European Central Bank

3.1.1 Price stability as the primary objective

The primary objective of the Eurosystem is to create price stability.11 Price stability is defined as a year-on-year increase of the harmonised index of consumer prices (HICP) for the Euro currency area of below, but close to, 2%. In the medium-term an inflation rate close to 2% should be maintained.12 There are several reasons, why an inflation of zero or close to zero is not desirable. The official values of the HICP tend to be higher as the effective price increases. A reason for that is for example that increases in quality are not observed sufficiently.

With a low inflation rate there is still a risk of deflation.13 The ECB´s monetary policy has to be consistent in its entire jurisdiction in order not to threaten the goal of price stability. It follows the policy of a free market economy, whereby an efficient effort of resources is encouraged.

The ECB focuses on implementing political measures and to guarantee that tasks will be complied successfully by the NCBs. It is especially responsible for the following fields:

- The ECB Governing Council is reliable for the monetary policy in connection with the common currency and immobilizes the policies in the Eurosystem. Part of that is also the definition of price stability, the selective of indicators to analyse the risk of inflation etc.
- Within narrowly defined limitations, the decision-making bodies are allowed to issue binding legal acts for the Eurosystem, to ensure that the NCBs are able to perform decentralized operations. Furthermore the decision-making bodies are able to pass regulations, which are binding out of the Eurosystem.
- The ECB is responsible for the strategic planning and coordination of the production and expense of banknotes in Euro. Furthermore it coordinates the research and development activities of the Eurosystem, as well as the security and quality of the production of banknotes. Additionally there is an analyse center for counterfeit money to analyse and classify counterfeit banknotes in Euro, the central database for Euro- counterfeiting and the international research centre for counterfeiting prevention located at the ECB.
- To represent its position on an international and European level, the ECB participates in meetings of different international and European forums. In December 1998, the ECB was the only central bank in the world, which received an observer status from the International Monetary Fund (IMF). It is now represented in every meeting of the executive board of directors of the IMF, which deals with relevant topics for the economic- and currency union. For this reason the ECB established a constant representation in Washington D.C. Furthermore it participates in meetings of the G7, the G20 and the Financial Stability Board (FSB). On the European level, the ECB president is invited to the meetings of the Eurogroup, the informal gatherings of all ministers of finance of the Euro area. The ECB can also take part at the meetings of the European council, whenever topics are discussed that have a direct linkage with the tasks and objectives of the Eurosystem.
- The ECB concludes, coordinates and controls all monetary political actions of the NCBs. It issues instructions to the NCBs concerning the necessary transactions (value, duration, point of time) and proves, if these were performed successfully.14

3.1.2 Miscellaneous tasks and objectives of the European Central Bank

- The ECB is committed to compose a monthly report, a consolidated weekly disclosure of the Eurosystem and an annual report according to article 15 of the statute of the ESCB.
- The ECB takes on the evaluation of security risks, which were acquired in connection with the ECBs investments of equity capital and reserve holdings or which are permitted as securities for credit transactions of the Eurosystem.
- The ECB and the NCBs have created a number of operative systems to simplify the performance of decentralized dealings. These systems offer the logistical support for the functional integrity of the Eurosystem and are conducted by the ECB.
- The ECB is reliable for the strategic and tactical administration of the currency reserves. Inherent is the determination of the strategical portfolio direction, the tactical portfolio direction, as well as the determination of facility guidelines and the entire confines.15

3.2 Tasks and objectives of the Federal Reserve System

The Fed follows a number of objectives, so that it is not possible to rank these goals after priority as possible with the ECBs objectives. A definition of the objectives can be found in the Federal reserve act since 1977 in paragraph 2A.1: “The Board of Governors of the Federal Reserve System and the FOMC shall maintain long growth of the monetary and credit aggregates commensurate with the country’s long run potential to increase productions, so as to promote effectively the goals of maximum employment, stable prices, and moderate long- term interest rates”. The monetary political tasks are so narrowly defined, but there are several ways, that the statutory objectives can be reached. The Fed can choose one goal arbitrary out of the number of goals.16 The monetary political ability to react shows that the Fed has an implicit inflation goal.17 According to Heine and Herr it is about 3%.18

In summary it can be stated that the Feds task is to influence the money supply in such a way that the economy grows at stable prices without threatening the financial markets and an equalization in the American balance of payments can be reached.19

4 Monetary policy instruments

4.1 Open market operations

4.1.1 Open market operations of the European Central Bank

Every liquidity resulting in transaction on the initiative of the ECB can be seen as an open market operation. The ECB uses open market operations to control interest rates (including the variable overnight rates) and liquidity, as well as to signal the position of its monetary policy in the Euro area.20 The focus is on the allocation of refinancing credits against asset backing in terms of limited transactions, active bonds, definite sales/purchases, forex swap transactions and the acceptance of time deposits.21 For the execution of these instruments, the ECB Governing Council has bilateral dealings at hand, the quick tender or standard tender, which again has to be divided into interest tender and quantity tender.

[...]


1 European Central Bank – The European Central Bank – The Eurosystem – The European System of Central Banks (2009) p. 16

2 cf. http://www.ecb.europa.eu/ecb/orga/decisions/govc/html/index.en.html

3 cf. Gischer, Herz, Menkhoff 2004 S.133

4 cf. European Central Bank - The European Central Bank - The Eurosystem - The European System of Central Banks (2009) p. 14

5 cf. http://www.ecb.europa.eu/ecb/orga/decisions/genc/html/index.en.html

6 cf. Pollack, Mishkin 2003 - p.340 et seq.

7 cf. http://www.Federalreserve.gov/pubs/frseries/frseri2.htm

8 cf. Pollack, Mishkin 2003 - p.337 et. seq.

9 cf. Pollack, Mishkin 2003 - p.339

10 cf. http://www.Federalreserve.gov/pubs/frseries/frseri3.htm

11 cf. Art. 2 of the Eurosystems statute

12 cf. ECB Working Paper Series No742 - March 2007 p.21

13 cf. Bernanke, Mishkin 1997 Working Paper No. 5893

14 cf. http://www.ecb.eu/ecb/educational/facts/orga/html/or_012.de.html

15 cf. http://www.ecb.eu/ecb/educational/facts/orga/html/or_013.de.html

16 cf. Walter 1994, p.56

17 cf. Ruckriegel/Seitz 2002, p.14

18 cf. Heine/Herr 2004, p.58

19 cf. Walter 1994, p.56

20 cf. http://www.ecb.int/mopo/implement/omo/html/index.en.html

21 cf. Europäische Zentralbank 2006, p.8

Details

Pages
16
Year
2010
ISBN (eBook)
9783640890170
ISBN (Book)
9783640889792
File size
541 KB
Language
English
Catalog Number
v170255
Institution / College
Cologne University of Applied Sciences
Grade
1,0
Tags
european central bank federal reserve system

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Title: The European Central Bank and the Federal Reserve System - a general comparison