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1. 1 The European Central Bank (ECB) and the Federal Reserve (the Fed):
differences and similarities in setup, operational procedure, and monetary policy
Akmal Rahimov
Hari Widodo
Yudha Hadiyanto
International Financial Economics
2. 2 OUTLINE: PART I : General Overview, Historical Background, Organizational Structure, Main Functions and Tasks of the Federal Reserve and ECB
PART II : Differences and similarities in Operational Procedures of Federal Reserve and European Central Bank
PART III : Monetary Policy
3. 3 PART I: General Overview, Historical Background, Organizational Structure, Main Functions and Tasks of the Federal Reserve Bank and European Central Bank (ECB)
4. 4 The Role of Central Bank Issuer of the currency
Controller of the money supply
Lender of the Last Resort
5. 5 Why the US need a central bank?
6. 6 Why the US need a central bank?(Continued)
7. 7 Why European System of Central Bank (ESCB) is needed?
8. 8 Historical Background FEDERAL RESERVE
Drafted by Congress as the Federal Reserve Act in 1913
The act began in 1908, when Congress set up the National Monetary Commission to pinpoint weaknesses in the nations financial system.
Triggering Factors : Monetary panic
(Bank commitment)
The commission found that the United States lacked a reliable method to provide liquidity to the money supply. EUROPEAN CENTRAL BANK
Established on 1 June 1998, as one of the worlds youngest central banks.
Triggering factors : the presence of EMU (political decision), i.e. to maintain price stability
EMU:
Stage 1: Restriction on the movement of capital were abolished (1990)
Stage 2:Establishment of EMI and ECB
Stage 3:Irrevocable fixing of exchange rate
9. 9 Historical Background(Continued) President Woodrow Wilson signed the Federal Reserve Act into law on Dec. 23, 1913, to help to maintain a stable, healthy and growing economy.
10. 10 Stages to Monetary Union 1. Maastricht Treaty
2. Establishment of the EMU
3. Irrevocable fixing of exchange rates
11. 11 Inseparable Story: EMU and the ECB Stage 1: Maastricht Treaty
12. 12 Stage 2 : Establishment of the EMU 1 January 1994 : The establishment of the European Monetary Institute (EMI)The EMI had no responsibility for the conduct of monetary policy in the European Union
December 1995 : the European Council agreed to name the European currency unit to be introduced the "euro", and confirmed that Stage Three of EMU would start on 1 January 1999.
December 1996 EMI also presented to the European Council, and subsequently to the public, the selected design series for the euro banknotes to be put into circulation on 1 January 2002.
13. 13 25 May 1998 : the governments of the 11 participating Member States (Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland) appointed the President, the Vice-President and the four other members of the Executive Board of the ECB.
With the establishment of the ECB on 1 June 1998, the EMI had completed its tasks. The EMI went into liquidation on the establishment of the ECB.
14. 14 Stage 3: Irrevocable fixing of exchange rates 1 January 1999 : the irrevocable fixing of the exchange rates of the currencies of the 11 Member States initially participating in Monetary Union was commenced along with the conduct of a single monetary policy under the responsibility of the ECB.
1 January 2001 : Greece joined the EMU, making the number of participating Member States increased to 12.
15. 15 Basic Tasks of Federal Reserve and European Central Bank Federal Reserve
manages supply of money and credit
keeps the wheels of business rolling
serves as the banker for the federal government by providing financial services for the U.S. Department of the Treasury
supervises and regulates a large share of the nation's banking and financial system;
administers banking and finance-related consumer protection laws.
European Central Bank
To define and implement monetary policy in Euro area
To maintain price stability and conduct foreign exchange operations
Holding and manage the official foreign reserves of the Member States
Promote the smooth operation of payment systems
Provide prudential supervision of credit institutions and the stability of the financial system
16. 16 Independence of the Central Bank
17. 17 Structure of the System of Federal Reserve
18. 18 Board of Governor of The Fed
19. 19 Federal District Bank (12) District Banks. There are 12 Federal Reserve Districts, or regions, throughout the United States. Regional headquarters are located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. Additionally, there are Branches of Reserve Banks in 25 other cities.
20. 20 Federal Reserve Districts and Branches Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
21. 21 Federal Open Market Committee
22. 22 Federal Open Market Committee
The FOMC has the primary responsibility for conducting monetary policy.
Director of each Reserve Bank contributes to monetary policy by making recommendations about the appropriate discount rate
23. 23 Member Banks
24. 24 Advisory Committee
25. 25
26. 26 Flow of Command in the FED
27. 27
28. 28 Executive Board
29. 29 Governing and General Council
30. 30 PART II: Differences and similarities in Operational Procedures of Federal Reserve and European Central Bank
31. 31
32. 32 Monetary Policy Framework ECB:
Primary objective of ECB is maintaining the price stability.
Operationally defined as controlling inflation to be less 2% in Harmonized Index Consumer Prices (HICP).
In evaluating the financial market condition, (M3) as quantitative reference.
Prediction of inflation and the risk price stability is crucial (broad based assessment)
33. 33 Monetary Policy Framework ECB announces target of money growth periodically since its inception
Using M3 as the evaluation tool to the financial market condition has some technical problem.
M3 is defined as currency, deposits, and marketable securities held by Euro-area resident.
34. 34
35. 35 Operational Procedure : ECB also provides overnight loans to banks with the marginal lending rate. The spread is determined by governing council.
The open market operations are done simultaneously by the NCB in the Euro-system.
The OMO involving coordination among 15 NCB and hundreds financial institutions. It becomes more complicated.
36. 36 Operational Procedure : Due to the differences in financial structure among the countries, ECB deals with more various collateral
7. The sheer volume of funds that is refinanced on regular basis is larger than that of the Fed therefore ECB set up more cumbersome and risky.
6.The Fed only deals with the US government securities as collateral.
37. 37 PART III: Monetary Policy Macroeconomic Performance
Monetary Policy Instruments
Monetary Policy Strategies
38. 38 Key economic characteristics of the Euro Area, US and Japan
39. 39 Unemployment rate in the Euro Area, the United States and Japan
40. 40
41. 41 Monetary Instruments
42. 42 Tools of Monetary Policy of Federal Reserve and ECB
43. 43 The instruments of ECBs monetary policy
Open market operations
The main refinancing operations are regular liquidity-providing reverse transactions with a weekly frequency and a maturity of two weeks.
The longer-term refinancing operations are liquidity-providing reverse transactions with a monthly frequency and a maturity of three months.
44. 44 The instruments of ECBs monetary policy
Fine-tuning operations can be executed on an ad hoc basis with the aim of both managing the liquidity situation in the market and steering interest rates, in particular in order to smooth the effects on interest rates caused by unexpected liquidity fluctuations.
In addition, the Eurosystem may carry out structural operations through the issuance of debt certificates, reverse transactions and outright transactions.
45. 45
46. 46 The instruments of ECBs monetary policy
Standing facilities aim to provide and absorb overnight liquidity, signal the general monetary policy stance and bound overnight market interest rates.
Marginal lending facility, is used by counterparties to obtain overnight liquidity from the NCBs against eligible assets.
Deposit facility to make overnight deposits with the NCBs.
47. 47 The instruments of ECBs monetary policy 3. Minimum reserves
The Governing Council of the ECB has decided to apply minimum reserves as an integral part of the operational framework for the monetary policy in Stage Three.
48. 48 Three Tools of Federal Reserve Monetary Policy 1.Establishing reserve requirements, the minimum proportion (percentage) of bank deposits they must keep on deposit at the Fed.
Increasing reserve requirements (%) increases the percentage of bank deposits kept in non-interest bearing deposits at the Fed and limits bank lending.
Decreasing reserve requirements (%) reduces the percentage of bank deposits kept in the Fed and provides the banking system with excess reserves.
Bank deposits (reserves) in the Fed are needed to clear checks and to satisfy reserve requirements.
49. 49 Three Tools of Federal Reserve Monetary Policy (Continued) Open market operations affect the level of member bank reserves and the monetary base.
Buying government securities from the private sector, the Fed eventually credits member bank deposits, thus increasing the level of bank reserves and the banks' ability to make loans and expand the money supply.
Selling securities (could be any asset) to private security dealers or banks, the Fed is paid with a bank check which reduces the level of member bank actual reserves
50. 50
51. 51 Three Tools of Federal Reserve Monetary Policy (Continued) Discount Rate Policy -- The rate of interest depository institutions pay for borrowing from the Fed.
Raising the discount rate increases the cost of borrowing for needed reserve balances.
Lowering the discount rate lowers the cost of bank liquidity and encourages lending and money supply expansion.
52. 52 Monetary Policy Strategy
53. 53
54. 54
55. 55
56. 56 An illustration of the transmission mechanism from interest rates to prices
57. 57
58. 58
59. 59 Two Pillars of ECBs Monetary Policy Strategy
60. 60 First Pillar of ECBs Monetary Policy Strategy: Economic analysis The Economic Analysis focuses mainly on the assessment of current economic and financial developments and the implied short to medium-term risks to price stability. Includes:
Analysis of real economy indicators.
Analysis of financial market developments.
Analysis of exchange rate developments.
Euro area macroeconomic projections based on technical assumptions, models and technical expertise of staff
61. 61 Second Pillar of ECBs Monetary Policy Strategy: Monetary analysis 2. Monetary analysis focuses on a longer-term horizon, exploiting the long-run link between money and prices. The monetary analysis mainly serves as a means of cross-checking, from a medium to long-term perspective, the short to medium-term indications for monetary policy coming from the economic analysis. Includes:
The analysis of special factors
A comprehensive assessment of liquidity and credit conditions
Analysis of components and counterparts of M3
62. 62
63. 63
64. 64 Conclusion There is no blueprint for the structure and operations of a central bank. Although the structures of the Federal Reserve System and the Eurosystem are similar, there are many differences in the way they operate.
The Eurosystem is more decentralized than the Federal Reserve.
65. 65 Conclusion
There is lesson for Fed to take from ECB:
To clarify the goals of monetary policy.
Disagreements remain over how to best make policy transparent while at the same time reserving the independence of the central banks.
Transparency of two FED and ECB has also increased.
It is harder for the ECB to forecast the monetary magnitude compared with the Fed due to the relatively limited data available from the past (only 5 years)
