directors, while three directors are appointed by the Board of Governors.** Directors
represent professional bankers, prominent business leaders, and public interests.
Federal Reserve Bank Functions: Monetary Policy: 1) Establish the discount
rate at which member banks may borrow from the Federal Reserve Bank.2)
Determine which bank receive loans. 3) Elect one member to the Federal Advisory
Council. 4) Five of the 12 bank presidents vote in the Federal Open Market
Committee. Board of Governors:1) The seven governors are appointed by the
President, and confirmed by the Senate, for 14-year terms on a rotating schedule.2)
All Board members are members of the FOMC.3) Effectively set the discount rate.4)
Serve in an advisory capacity to the President of the United States, and represent
the U.S. in foreign economic matters. Federal Open Market Committee
Meeting: Important agenda items includes 1) Reports on open market
operations.2) National economic forecasts are presented.3) Discussion of monetary
policy and directives, including views of each member.4) Post-meeting
announcements, as needed. How Independent is the Fed: 1) A broad question of
policy for the Federal Reserve Systems is how free the Fed is from presidential and
congressional pressure in pursuing its goals.2) Instrument Independence: the ability
of the central bank to set monetary policy instruments.3) Goal Independence: the
ability of the central bank to set the goals of monetary policy.4) Evidence suggests
that the Fed is free along both dimensions. The European Central Bank: 1)
Founded in 1999 by a treaty between the European Central Bank (ECB) and the
European System of Central Banks (ESCB).2) The ECB is housed in Frankfurt,
Germany.3) Executive board consists of the president, vice president, and four
members, all serving eight-year terms.4) The policy group consists of the executive
board and governors from the 11 member countries central banks. Difference
between the Fed and the ECB: 1) Budgets of the Fed are controlled by the BOG,
while the National banks that make up the ECB control their own budgets.2)
Monetary operations are conducted at the national level, not directly by the ECB.3)
The ECB is not involved in bank regulation or supervision.4) Only the 18 members
attend the monthly meetings of the ECB, with no staff.5) No voting! All decisions
are made by consensus.6) The ECB holds a press conference following the monthly
meeting, while the Fed typically doesnt. Bank of Canada: 1) Founded in 1934.2)
Directors are appointed by the government for three-year terms, and they appoint a
governor for a seven-year term.3) A governing council is the policy-making group
comparable to the FOMC.4) In 1967, ultimate monetary authority was given to the
government. However, this authority has never been exercised to date. Bank of
England: 1) Founded in 1694.2) The Monetary Policy committee compares with the
U.S. FOMC, consisting of the governor, deputy governors, two other central bank
officials, plus four outside economic experts. 3) The Bank was the least independent
of the central banks, until 1997, when it was granted authority to set
interest rates.4) The government can step in under extreme circumstances, but
has never done so yet. Bank of Japan: 1) Founded in 1882.2) The Policy Board sets
monetary policy, and consists of the governor, two vice governors, and six outside
members. All serve five-year terms.3) Japans Ministry of Finance can exert
authority through its budgetary approval of the Banks non-monetary spending.
Case for Independence:1) The strongest argument for independence is the view
that political pressure will tend to add an inflationary bias to monetary policy. This
stems from short-sighted goals of politicians. For example, in the short-run, high
money growth does lead to lower interest rates. In the long-run, however, this also
leads to higher inflation.2) The notion of the political business cycle stems from the
collateral.*Because of this they generally have very high interest rates. The net
worth is the owners stake in a firm - the value of the firms assets minus the value
of its liabilities.* Net worth serves the same purpose as collateral.* If a firm defaults
on a loan, the lender can make a claim against the firms net worth.* The
importance of net worth in reducing adverse selection is the reason owners of new
businesses have so much difficulty borrowing money.* Most small business owners
must put up their homes and other property as collateral for their business loans.
Moral Hazard: Problem and Solutions: 1) The phrase moral hazard originated
when economists who were studying insurance noted that an insurance policy
changes the behavior of the person who is insured.2) Moral hazard arises when we
cannot observe peoples actions and therefore cannot judge whether a poor
outcome was intentional or just a result of bad luck.3) A second information
asymmetry arises because the borrower knows more than the lender about the way
borrowed funds will be used and the effort that will go into a project.4) Moral hazard
affects both equity and bond financing. Moral Hazard in Equity Finance:1) It is
more likely that the manager will use the funds in a way that is most advantageous
to them, not you.2) The separation of your ownership from their control creates
what is called a principal-agent problem. Moral Hazard in Debt Finance:1) When
the managers are the owners, moral hazard in equity finance disappears.2) Because
debt contracts allow owners to keep all the profits in excess of the loan payments,
they encourage risk taking.3) Lenders need to find ways to make sure borrowers
dont take too many risks.