im19 - Chapter 19 Organization of Central Banks Overview...

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Chapter 19 Organization of Central Banks Overview The structure of the Federal Reserve System is complex, but some understanding of it is necessary as background to the study of monetary policy. This chapter highlights the difference between the high degree of decentralization of the Fed that exists on paper and the high degree of centralization that exists in reality. The chapter also discusses the public interest view of Fed motivation—which holds that the Fed acts in the interests of the general public—and the principal-agent view—which holds that the Fed acts to increase its power, influence, and prestige as an organization, subject to constraints placed on it by the President and Congress. One implication of the principal-agent view is that the Fed might act to create a political business cycle: lowering interest rates in order to stimulate economic activity prior to elections in order to curry favor with Congress or the President. The evidence in favor of the existence of a political business cycle is at best mixed, however. The chapter also presents a discussion of the arguments for and against the Fed remaining independent of Congress and the President. An independent Fed is said to be able to avoid the myopic tendency of elected officials to be concerned more with the short-term benefits of a stimulative policy than with its long-term costs. The argument against an independent Fed raises the point that in a democracy a matter as important as monetary policy should be directly in the hands of elected officials. Central bank independence in other countries is also considered. The degree of independence among central banks in different countries varies. The central banks of some countries are quite independent, but the central banks of others, Japan for instance, are much less so. An independent central bank appears to improve an economy’s performance by maintaining a lower rate of inflation without adversely affecting output or employment. The chapter concludes with a discussion of the European Central Bank. Outline I. Power Sharing in the Federal Reserve System A) The Fed’s organization was shaped by the struggle between advocates of strong economic institutions and those who feared large, powerful economic interests. B) With the abolition of the Second Bank of the United States in 1836, private institutions, such as the New York Clearing House Bank, attempted to fill the role of lender of last resort. C) Severe nationwide financial panics led Congress to pass the Federal Reserve Act in 1913, setting up the Federal Reserve System . D) The Federal Reserve Act divided the United States into 12 Federal Reserve districts, each of which has a Federal Reserve bank in one city to conduct discount lending. 1. Federal Reserve district boundaries were intentionally drawn to contain a mixture of
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im19 - Chapter 19 Organization of Central Banks Overview...

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