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MonetaryPolPart3- US.pdf

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University of Waterloo
ECON 304
Jean- Paul Lam

Economics 304 - Winter 2013 Monetary Theory Jean-Paul Lam March 12, 2013 U.S Monetary Policy: A Very Brief Tour noi tcudort1nI The objective of monetary policy in Canada is very clear. ortiaint2%aonda band that can vary between 1 and 3 per cent. The overnight rate is the main instrument that the Bank of Canada uses to implement monetary policy. But as we have seen in the previous lecture, the Bank of Canada has recently used other (unconventional) tools during the financial crisis. In the previous lecture, we also had an overview of how monetary policy is conducted at the Bank of Canada and some of the indicators/data that the Bank of Canada uses in the formulation of monetary policy. We finish our description of monetary policyoiignviwofw the Federal Reserve is organized in the United States, how it conducts monetary policy and the influence U.S monetary policy has on Canada. ?derutcurtS evrese RlaredeFehtswiH The Federal Reserve System (the Fed) was established by an ActofCongressin1913. Thefinancial panic of 1907 led congress to consider the creation of a centr al bank. After the US civil war until the creation of the Federal Reserve Bank, the US experienced several bank panics (1873, 1884, 1890, 1893 and 1907). The banking panics of 1893 and 1907 wereparticularly important. Many big banks failed across the country and it was evident at the t ime that to provide stability, a lender of the last resort with su▯cient resources to stop runs on illiquid but still solvent banks was needed. President Wilson signed the Act and the creation of the Fed is viewed as his biggest accom- plishment. The Federal Reserve Act of 1913 called on the Fed t o(i)actaslenderofthelastresort and (ii) manage the gold standard to avoid sharp swings in interest rates and other macro vari- ables. Since the abandonment of the gold standard, the secociefeFdwasagd to “conduct monetary policy by influencing monetary and credit conditions in pursuit of maximum employment and stable prices, and moderate long-term interest rates.” In addition to these two objectives, the Fed is also responsible for supervising and regulating the banking institutions (the Bank of Canada does not have a direct supervisory role), provides financial services to depository institutions, the U.S gove rnment and foreign financial institutions including playing a major role in operating and supervising the payments system. The Congress when they created the Fed wanted to give representation to all parts of the U.S such that the Fed in Washington would receive information about each part of the country. The Board of Governors was established in Washington, and twelvealveiins (Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, San Francisco) were created. The Congress structured the Fed to be independent within the government—that is, although the Fed is accountable to the Congress and its goals are set by law, its conduct of monetary policy 1 is insulated from day-to-day political pressures. The FedilioheBnkofCndaihi regard. What makes the Fed independent? Three structural features give the Fed independence in its conduct of monetary policy: the appointment procedure for Governors, the appointment procedure for Reserve Bank Presidents, and funding. 2.1 Appointment procedure The seven Governors on the Federal Reserve Board are appointed by the President of the United States and confirmed by the Senate. Independence derives fro mac olof: he appointments are staggered to reduce the chance that a single..ritcdl kelhe appointees; second, their terms of o▯ce are 14 years–much longer than elected o▯cials’ terms. Appointment procedure for Reserve Bank Presidents: Each Reserve Bank President is appointed to a five-year term by that Bank’s Board of Directors, subject to final approval by the Board of Governors. This procedure adds to independence because the Directors of each Reserve Bank are not chosen by politicians but are selected to provide a cross -section of interests within the region, including those of depository institutions, nonfinancial businesses, labor, and the public. This is again very similar to the Board of Directors of the Bank of Canada. Funding: The Fed is structured to be self-su▯cient instehteha senit meets its operating ex- penses primarily from the interest earnings on its poroofsecurities. Anysurplusesareremitted to the government (on average this is around $25 billion but they have been much higher recently, around $90 billion. The Bank of Canada’s funding operates inasi lsi. hrr,ii independent of Congressional decisions about appropriations. Fed o▯cials report regularly to the Congress on monetic ar,ypgullatory policy, and a variety of other issues, and they meet with senior Administration o▯cials to discuss the Federal Reserve’s and the federal government’s economic programs. The Fed alsoreportstoCongressonitsfinances. One of the most watched o▯cial meeting is the testimony of the chairman to congress. 2.2 Who makes monetary policy? The Fed’s FOMC (Federal Open Market Committee) has primary responsibility for conducting monetary policy. The FOMC meets in Washington eight times a year (again similar to the Bank of Canada) and has twelve members: the seven members of the Boardo fGvrrshePdntf the Federal Reserve Bank of New York, and four of the other Reserve Bank Presidents, who serve in rotation. The remaining Reserve Bank Presidents contribute to the Committee’s discussions and deliberations. In addition, the Directors of each Reserve Bank contribute tomorclymaig recommendations about the appropriate discount rate, whichareuetofinlpralyte Governors. knaevrese RlaredeFehtfos looTnas laG The goal(s) of the Federal Reserve Bank are fairly similar to he Bank of Canada, although the framework is not as transparent as in Canada. Monetary policy in the U.S has two basic goals: 2 to promote “maximum” sustainable output and employment andto promote “stable” prices. These goals are prescribed in a 1977 amendment to the Federal Reserve Act. Sustainable output would correspond to steering the econom ys hhttitn-,i grows at the same rate at which capacity (potential output) isgrowing. eswinth
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