ACADEMIC GUIDE
1 US FED 2 US FED INDEX
Letter from the Secretary-General and the Undersecretary- 4 General
Letter from the Undersecretary-General for Specialized 6 Agencies
Letter from the Dais and the Situation Room 8
Brief description of the committee 10
Topic A: Reevaluation of FED competences 18
Topic B: Operative capacities of the organization 27
Specifics on procedure 34
QARMAS 36
Bibliography 37
3 PRESENTATION LETTER LETTER FROM THE SECRETARY-GENERAL AND THE UNDERSECRETARY GENERAL
T E S , From the Office of the Secretary-General, it is with great pleasure that we welcome you to the ninth version of the Modelo de Naciones Unidas de la Universidad de los Andes.
My name is Jordi Enrique Buitrago Soetendal. I am a fourth- year Law student with a minor in International Studies at the Universidad de los Andes. For MONUA 2020, I have the honour of accomplishing the biggest dream of my MUN career: serving as Secretary-General of MONUA. I have been participating in MUN conferences for the last eight years, and MONUA 2020 is with no doubt the most complex and exciting challenge I have faced during all these years. Besides MUN, I
D E A R L G am passionate for my career, particularly for Criminal Law, as well as football and literature.
On my behalf, I am Santiago Paz Ramos, a fourth-year Economics major with minors in International Relations and Law. In this edition, I have the huge honor to continue building dreams by your side, by serving as Undersecretary-General for MONUA 2020. I have been participating in these conferences for the past 7 years now, and each day I learn something new, meet one-of-a-kind people, and surpass the barriers of what I think I am capable of. Personally, asides from being deeply passionate about these conferences, I am profoundly interested in Political Economy, Macroeconometrics and music.
4 PRESENTATION LETTER LETTER FROM THE SECRETARY-GENERAL AND THE UNDERSECRETARY GENERAL
We aspire to exceed the expectations you have from us in this edition of MONUA, by managing to build up an experience that is equally both welcoming and challenging, so as to encourage you to leave your comfort zones and challenge the boundaries of the self. For all other matters, we remain at your entire disposition, and we warmly welcome you beforehand to MONUA 2020.
Best regards,
Jordi Enrique Buitrago Soetendal - Secretary-General for MONUA 2020
Santiago Paz Ramos - Undersecretary-General for MONUA 2020
5 PRESENTATION LETTER LETTER FROM THE USG FOR SPECIALIZED AGENCIES
It is with pride that I welcome you to the Ninth version of the
T E S , Model of United Nations of Universidad de Los Andes (MONUA 2020). My name is Daniel Alberto Castañeda Eslava, I am 20 years old, an undergraduate student of the sixth semester of Psychology and Economics in this institution. It is for me an authentic honor to serve as Under-Secretary-General for Specialized Agencies. My goal for this year is to develop a truly rigorous academic exercise and to accompany an experience that will stand out for its challenging, academic and innovative character but, above all, for its excellence and human quality. MONUA is for me an environment filled with opportunities for all its attendants since we aim for the development of an unforgettable and fruitful experience. D E A R L G While being part of MONUA, you will notice that most of the in-committee experience allows you to enhance your qualities as a delegate by breaking your limits and creating new sets of possibilities, thus enriching your development in soft, academic and interpersonal skills. Conjointly, most of the social experiences will be the scenario in which you will forge a constitutive pillar of your development as a person, learning more and more about the challenges and goals that each one of you has in the Model of the United Nations world and, even more, in real life. After all, getting to know new people will give you new ideas and fill you with a global perspective, giving you the best possible moments in MUN you could ever have. MONUA 2020 is the legacy of people who wanted to build something unseen before, that is why to challenge ourselves
6 PRESENTATION LETTER LETTER FROM THE USG FOR SPECIALIZED AGENCIES
to be excellent and go beyond what we thought possible of us is the least we can do in an environment such as this one.
Furthermore, this Undersecretariat will search to signify and redefine the capacities of most of the organizations here present, which means that delegates will be challenged to empower their creativity by knowing the essence of an institution and recreating it to its core. Being this new for the Colombian circuit, the delegate will have, not only to redefine to the committee by its own hand and lobbying skills but to redefine itself while being the one who carries real power on the organism. As a result, having dynamic processes that will challenge the soft skills of the delegate and lead them towards excellence, giving them the ability to represent and create structures that are reliable to the specific organism and its environment. Finally, it is worth noting that we have given our best, with the exceptional team of eleven staffers that make up this undersecretariat, in order to grant a lasting and comprehensive experience that you will never forget. Concluding, with nothing more to say, we expect MONUA 2020 to be an experience filled with joy and opportunities through these five days. Remember, your legacy is being written by yourself, give your best on this experience. “Capitalism is altruistic, and it requires a certain altruism of each of us.” -Hendrith Smith
Sincerely, Daniel Alberto Castañeda Eslava Under Secretary General for Specialized Agencies
7 PRESENTATION LETTER LETTER FROM THE DAIS AND THE SITUATION ROOM
We are really glad to welcome you all to MONUA 2020 and
T E S , the Federal Reserve System. As you know, MONUA has always been a conference that pushes boundaries when it comes to the election of its committees, that is why this year our proposal is based on academically demanding topics. The FED serves as the central bank of the United States, the biggest economy on earth. Thus, each of its decisions has long-lasting and controversial effects on the national and international economies. Having said that, we will present the team that will lead the debate during the conference.
The first member of the Dais is Santiago Romero, who majors in Economics at the University of Los Andes. Santiago is
D E A R L G also a former member of the Crisis Team, the international delegation that represents the university at many prestigious crisis-type models. Passionate about public economics, Santiago is very interested in macroeconomic theories and government affairs. Furthermore, he is very fond of the correct use of technical vocabulary and always seeks precision when presenting. The second member of the Dais is Daniel Bedoya Sanin, who is currently finishing its Masters Degree in International Studies. As Santiago, Daniel studied Economy at Universidad de los Andes and participated in several MUN’s in Colombia as well a two times in the Harvard’s National Model of United Nations with the university’s official delegation. He is interested in international trade, sustainable development, macroeconomic and tax policy and international trade law as well as feminism. During committee sessions, Daniel is very
8 PRESENTATION LETTER LETTER FROM THE DAIS AND THE SITUATION ROOM
focused on the correct and respectful usage of procedure and encourages delegates to always share their knowledge with others. For him, every experience and opportunity is a chance to learn and to grow, and the best knowledge is the one built by working together.
In the Situation Room, we have Nicolas Garrido, who currently majors in Economics with minors in Administration and Psychology at the University of Los Andes. Nicolas loves to play volleyball and in his spare time, he enjoys reading biographical books. He is a former member of ONUANDES LATAM, a delegation that participates in the Latin American UN simulation of Harvard University. His emphasis is on behavioral economics and nothing matters more to him in a delegate than their values.
Having introduced both the Dais and the committee, there is nothing left but to wish you the best experience in MONUA and offer you our assistance with anything you need.
Sincerely,
Santiago Romero [email protected] Nicolás Garrido [email protected] Daniel Bedoya [email protected]
9 US FEDERAL RESERVE BRIEF DESCRIPTION OF THE COMMITTEE
The Federal Reserve System, often known as the FED, is the central bank of the United States. Created by Congress in 1913, it is the entity in charge of promoting a sound monetary and financial system for the nation (Federal Reserve, 2019). The existence of a central bank results vital for long term stability and the creation of proper economic conditions throughout the monetary system. In fact, central banks are designed in part to help the financial system meet occasional liquidity strains. When demands for liquidity rise, central banks can respond by increasing the supply of money and thus adding liquidity to the system.
Since it was created to broadly cover the main issues of the American economy, the FED serves five principal functions:
1. Conduction of the nation’s monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy;
2. Promotion of the stability of the financial system and effort to minimize and contain systemic risks through active monitoring and engagement in the U.S. and abroad;
3. Promotion of the safety and soundness of individual financial institutions and monitoring of their impact on the financial system as a whole;
4. Fostering of payment and settlement system safety and efficiency through services to the banking industry and the U.S. government that facilitate U.S.-dollar transactions and payments.In other words, they provide special services to banking industries in crisis times. For example, central banks usually serve as a last resource loaner to national banks when economic crisis arrive.
5. Promotion of consumer protection and community development through consumer-focused supervision and examination, research and
10 analysis of emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations.
These functions are carried out by three entities that are all part of the Federal Reserve System: the Federal Board of Governors, the Federal Open Market Committee (FOMC) and the Federal Reserve Banks. Taking this into account, it is important to notice that the FED shares various characteristics with private sector entities, but even so, its goal is to serve the public interest. Since its foundation, the Federal Reserve has been supervised by the U.S. Congress, making it a public institution (Federal Reserve, 2019) . It is important to remark that the FED is an independent body and neither the legislative nor the executive branch have a direct influence on the decisions it makes.
Each of the 12 Reserve Banks has its own nine-member Board of Directors (BoD). Each BoD consists of six members elected by commercial banks that hold stock in that district’s Reserve Bank and three members that are appointed by the Board of Governors. One of those members is appointed as Director.
Figure 1. Composition of the Federal Reserve. Taken From: Federal Reserve
11 As it can be seen in figure 1, the Federal Open Market Committee have both the board of governors and the local Federal Reserve Banks presidents. Therefore, in MONUA, all the delegates will be members of the Federal Open Market Committee, so the actions taken during the committee will have a direct impact on the economy of the United States. Since there are both members of the Federal Board of Governors and the presidents of the local reserve Banks the committee will enhance a diversity of economical positions and single state interests. At the same time, it is important to highlight that, considering the different political alignments and the current needs of the FED, there will be several delegates which, even if they are not regularly present on the committee, will be present and in full capacity for the voting and decision-making procedure.
In the committee delegates can take all the actions that the Federal Reserve has to tackle the different problematics. It is highly important to mention that interest rates can be modified in order to adjust consumption, investment and deposits. Therefore, it is important to mention the basic macroeconomic identity:
Y= C + I + G + NX ( Exp - IMP) Where Y: Domestic Product C: consumption I: investment G: government expenditure NX: commercial balance EXP: Export Imp: Import
The interest rates affect consumption and investment negatively when they are raised because people will prefer to save money since they can have higher returns when putting money into their banks. On the other hand, if interest rates are decreased this will make people put out their money from their banks, augment their borrowing since is less expensive, and start investing or consuming. In this order of ideas, the movement of the interest rates is used to maintain product stability when there is an impact over demand or government expenditure changes.
12 Secondly, it is important to mention that the government has over its control the monetary resources that are circulating through the economy. For this reason, the FED has a role over the inflation the country is facing. When a central bank injects liquidity into the economy it is making the economic resources to lose value since the resource becomes more abundant. This is explained by the Quantitative Theory of Money (QTM). It explains that a direct relation between level prices of goods and services and the quantity of money in an economy thru this simple equation:
MV=PT (M: money supply, V: velocity of circulation, P: average price levels and T: Volume of transactions of goods and services).
The Federal Reserve has in its hand the correct use of monetary resources to balance the economy and prevent it to have high inflation rates or deflation, which happens when there are not sufficient resources to sustain the economic activities. The FED also uses an array of additional resources it has at its disposal such as trading of Treasury Bonds, which are marketable securities issued by the government with a maturity range of 10 to 30 years. Interest on them is paid every six months and since they are issued by the U.S. Treasury, they are insured by government funds. Nevertheless, efforts to control inflation are often insufficient, since it is very complicated to correctly determine the amount of money effectively circulating in the economy. Another cause might be that because of increasingly open national markets, central banks might lose their ability to set prices, for imports often react to international price surges (The Telegraph, 2015).
Finally, the FED can use Quantitative Easing (QE) also known as large scale asset purchases. This form of monetary policy is not common to be used and it is normally criticized. By this unconventional method, the FED injects liquidity into the financial system buying a predetermined amount of financial assets, normally government bonds. QE is usually used when the standard monetary policy, mentioned before, has become ineffective fighting low inflation because of the liquidity trap, further explained.
13 Therefore, all delegates should be prepared to face constant challenges guided by the staff of the committee. All of the mechanisms mentioned will be considered during the committee and it is up to all the members to discuss which mechanisms can be used to solve different problematics presented latter.
Specifically, the main objectives of the committee are:
1. Analyze what should be the best decisions that FED could make in the possible future for facing the economy slowdown.
2. Focus on whether the FED should keep the liberalization present since the Reagan administration, or if a new regulation should be implemented and what kind.
3. Recognizing the entirety of the Federal Reserve System with its capacities and actions on the current economy of the United States while still being at the Federal Open Market Committee.
US FEDERAL RESERVE HISTORICAL CONTEXT OF THE COMMITTEE
It was 1907 when after weeks of turmoil a massive fall from the New York Stock Exchange occurred. Bank runs and a massive loss of clientele were experienced by many of the biggest US financial institutions, further strengthening a recession that would inevitably come in October. A number of businessmen lead by J.P. Morgan lent large sums from their own money to ease some pressure on the private banks, thus allowing them to resume their operations (Federal Reserve History, 2015). This crisis made the necessity of an independent central bank obvious, for the injection of liquidity into the market was needed at the time and no governmental institution had the ability to do so. Nelson W. Aldrich, a prominent Republican senator at the time, who was a member of the Senate Finance Committee and a founder member of the National Monetary Commission, was one of the main proposers of what is now
14 known as the Federal Reserve System. Signed in 1913 by president Woodrow Wilson, the Federal Reserve Act passed as a hybrid of the Aldrich plan, which favored a privately controlled central bank, and the then democratic government plan, which favored a state-controlled system(Federal Reserve History, 2015).
This Act created the FED system, which consisted of twelve regional Federal Reserve Banks which controlled the money supply and served as a lender of last resort. As time passed, the complexity and scope of the FED stirred into a more active role in the domestic economy. The new elements incorporated during this act were revolutionary for the time. A relevant characteristic of this central bank was the combination between both private and public elements.
From the beginning of the Federal Reserve System, the United States was divided into 12 Districts, each with its own Reserve Bank and with independence from one another. These Districts were formed considering trade regions and other economic aspects such as the commercial relations of the different districts. The System’s structure encourages exploration of a diverse range of views and promotes a healthy policy debate. Each Reserve Bank has an independent research department, with its own external publications. In addition, while the members of the Board tend to focus on developments in the nation as a whole, the Reserve Bank Presidents bring specialized information about their regional economies to the FOMC discussion. (Kemmerer, E. 1936 ).
After several revisions and The Depository Institutions Deregulation and Monetary Control Act of 1980 (Monetary Control Act) were enacted, the degree of coordination between Reserve Banks was increased and nowadays they usually share the same pricing of financial services offered to depository institutions. They also tend to develop systems inside the FED that facilitate the division of tasks with national scope to coordinate efforts.
15 US FEDERAL RESERVE PRESENT-DAY SITUATION
Since the 2008 Financial Crisis the Federal reserve has been the object of strong criticism due to the devastating consequences it had over the United States economy.
In the first place, the financial crisis of 2007–2008 has been viewed as the worst since the Great Contraction of the 1930s. Triggered by the decline in the prices of residential properties (houses) in the USA at the end of 2006 and the beginning of 2007. An enormous quantity of Subprime mortgages were issued and when the decline in prices began, it became more and more difficult to refinance those mortgages. During the Financial Stability Report of 2006 it was issued that such structured credit products were one of its main concerns, especially if financial markets take a turn for the worst and liquidity dries up. Taking into consideration the excellent performance of the economy during these decade those products were developed in a decade when interest rates have been low, appetite for risk was high.
Four principal causes can be identified when talking about the financial crisis
1. the high leverage of the financial system as a whole (Blanchard, 2009) with banks increasingly financing their assets with shorter maturity instruments 2. the change in the business model of banks which switched from the traditional lending model to equity culture, further explained. 3. the opacity of the structured finance products that resulted from the process of risk transfer (Blanchard, 2009) 4. the high level of interdependencies between the financial institutions (Blanchard, 2009)
16 The role of the FED in the financial crisis was heavily criticised and it generated the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act provided that directors representing financial institutions may not participate in the appointment of Reserve Bank presidents and first vice presidents. The Federal Reserve Board has long had policies preventing Reserve Bank directors from participating in supervisory matters or in determining the appointment of any Reserve Bank office. These directors continue to provide highly valuable information about developments in their markets, and take part fully in other roles with the other six directors. Nevertheless, as presented in the following topics the consequences of the financial crisis still exist and have to be discussed.
Furthermore, it is important to talk about the problematic presented between the measures adopted by the FED and the current president of the United States Donald Trump. Due to his trade war with China, Trump has repeatedly blamed the Fed’s interest rate policy for concerns about a slowing U.S. economy. He has contended the central bank has not moved quickly enough to ease monetary policy.
Due to the fact that political measures could end in higher inflation rates, It has been established by macroeconomists since the mid 1990s that independent central bankers are likely to control inflation at a lower cost in terms of output volatility. This is why, the director of the Federal Reserve Jerome H. Powell has not taken measures that can accelerate the inflation rates getting it away from the inflation target.
The declaration from President Trump have caused several impacts over the macroeconomic situation of the United States. As it can be seen in the figure 2, people expectation is changing toward a decrease in the interest rates of the Federal Fund Rates. This poses a serious challenge to the FED to control the inflation target.
17 Figure 2. Expectation of Federal Fund Rates. Taken from Chicago Mercantile Exchange.
These events have dramatically affected the monetary policy of the United States and therefore created debate towards the measures the FED has been taking. In the next two topics, these scenarios will be explained in more detail during the presentation of the topics.
TOPIC A: REEVALUATION OF FED COMPETENCES BRIEF DESCRIPTION OF THE TOPIC
The structure of the FED mentioned before has been the object of several critics. Different economists have established the role of this entity as for maintaining economic stability. Although, this has not been sufficient enough. For example, Milton Friedman blamed the FED as the main responsible for the great depression crisis because of the inappropriate actions such as the liquidity reduction that eventually became a cause of the 1929 crisis (Golden, 1974). Nowadays, criticism towards the FED continues and it has raised since the world recession of 2008, when the United States government was widely criticized for its lack of preventive measures and the FED was criticized for failing to stem the tide of toxic mortgages. John B. Taylor, blame the Federal Reserve actions of keeping
18 interest rates low after the 2001 world crisis as one of the major causatives of the bubble in the house prices of 2008.
Internationally, there seems to be a consensus about the characteristics of an efficient central bank (Cano, 2018). That literature emerged as a direct response to the apparent inability of central banks to efficiently develop a policy to guide a country while ignoring political bias. A central bank needs to be independent of political influence, yet accountable for its actions. The latter quality entails that the central bank must be transparent in its decision-making, which includes coherence and clarity in communicating its decisions to the legislature, the markets and the public at large. Transparency and accountability require that the central bank should be constrained by clearly articulated goals that are mandated by the political authorities but should enjoy “instrument independence” in deciding what means to use in pursuing these objectives.These two characteristics are vital for obtaining people trust in the currency, as well as, for having in line the consumer inflation expectation with the inflation goal set by the Central Bank. This is why a more transparent central bank is desired by the majority of central banks around the world. However, does the FED have complete independence toward its decision making or should it be taken into consideration reforms due to the current scenario between the FED members and President Donald Trump?
TOPIC A: REEVALUATION OF FED COMPETENCES HISTORY OF THE TOPIC
Throughout its history, the banking system has lived several transformations which, clearly, have modified the internal structure of the banking industry. As a matter of fact, before the creation of the United States Federal Reserve System, there were several banks of the United States. In the beginning, the First Bank of the United States suffered from public distrust, causing that the renew of their original 20-year charter, became a complete failure. Six years later, on 1817, the Second Bank of the United States was founded. Nonetheless, this bank was not generally understood by the public and was regularly opposed
19 by President Jackson during the time, reason why its renewal, during his second presidential campaign, became an issue. Formally, the consequences of the relationship between the President of the United States and the central bank converged on the veto of the President to the reformation bill presented in 1832. Eventually, this bank’s role was unsettled and became a state bank before closing. Later on, in 1908, the recent panic in 1907 generated a specific legislation for issuing emergency currency, creating the National Monetary Commission by The Aldrich-Vreeland Act. This organism was in charge of determining what changes the monetary system might need and which laws were necessary for the assertive assessment of currency and banking (Kansas FED, 2012). Above all, if there is something to recognize on this initial structure, is the need for clear accords and institutionality regarding monetary policy. Of course, this meant a more independent structure and at least some clear guidelines to follow as an organism. At the same time, public notion and the presidential opinion interfered with an assertive employance of the mandate of the central banks previously explained, meaning that autonomy must be guaranteed for defining, internally, the new approaches that a central bank should have. After all, transformations and reforms are in line with the changing times, and even if this might seem too much until this moment, let us take a close look to the following paragraphs.
On the other hand, as there was a serious lack of institutions, President Woodrow Wilson, in 1913, signed the legislation for the Federal Reserve through its act. Specifically, this act took care of the public concern regarding Wall Street and the powers of Washington, configuring the decentralized structure we know today with 12 regional Reserve Banks. Furthermore, to broaden its capacity, the Banking Act of 1933 was passed, creating tools and organisms related to the Federal Reserve System such as the FDIC, separated deposit and investment banks, the creation of the Federal Open Market Committee (FOMC). Also, it is important to highlight that the leading role of the New York Federal Reserve Bank was restrained during this specific legislation. Moving on, recognizing the needs for a more autonomous and independent structure, the Banking Act of 1935 was passed in order to centralize the control of the System to the Board and create the current structure of the FOMC. However, on the following decade, most of the monetary policy had been conducted
20 to support the expenditure and debt coming from the government due to the World War. However, the chair of the FED decided there was a need for conjuring new reforms on the approach of monetary policy, this were settled as to support the adverse business conditions, and through the establishment of complete independence, in terms of approval of monetary policy, from the Treasury on 1951 (Kansas FED, 2012). Summarizing, since its creation, the FED has passed through several substantial reforms as stated before. However, these reforms have been based upon the different needs established during these disruptive moments of history, giving this institution a more stable and skillful system which, even if it might need some restructuring, collaborates between each of its branches.
Thirdly, on the 1970s, the nation faced wide uncertainty regarding the recent situation of the economy, orquestating a series of legislative attempts to influence the FED’s decisions. Formally, the inflation was tackled through the congressional support of a proposal that aimed for an specific money supply growth target. Later on, during the Reagan and Bush administration, the attacks towards the FED escalated since inflation and unemployment rose rapidly. Specifically, this turned out to be a constant political battle, where the government argued on a lawsuit that they should be the ones who appointed the presidents of the Federal Reserve banks. This series of events led to the resignation of the chairman of the FED, Volcker, by succession of Alan Greenspan, who was widely criticized by the congress over his relationship with the current President of the US (Kansas FED, 2012). Nowadays, as stated on the initial paragraphs, the questioning for a new structure of the FED has risen, considering the political tensions and financial crises lived from the 2000 until today. So, as you may have seen until this point, the objectives, structure and composition of the FED System is far from leaving behind politics, but also should be aware of the different responsibilities it has to reform itself and, even, create new tools.
21 TOPIC A: REEVALUATION OF FED COMPETENCES SUBTOPIC A: NEW SELECTION PROCESS OF THE BOARD OF GOVERNORS
As mentioned before, the Board of Governors of the Federal Reserve system is nominated by the President and ratified by the senate. The maximum time allowed for a person to work in the board is 14 years and the term begins every two years, on February 1st of even-numbered years. The Board of Governors of the Federal Reserve (“the Board”) is one component of the nation’s central bank. The mission of the Board is to foster the stability, integrity, and efficiency of the nation’s monetary, financial, and payment systems so as to promote optimal macroeconomic performance (Federal Reserve, 2019).
The Board has several goals with interrelated and mutually reinforcing elements. Nonetheless, these objectives should not be confused with the ones stated before, which are related to the entirety of the Federal Reserve System. Especifically, these are three primary goals established as follows:
1. To conduct monetary policy that promotes the achievement of maximum sustainable long-term growth; price stability fosters that goal. 2. To promote a safe, sound, competitive, and accessible banking system and stable financial markets. 3. To provide high-quality professional oversight of Reserve Bank operations and to foster the integrity, efficiency, and accessibility of U.S. payment and settlement systems.
Currently, the members of the Board of Governors are selected through a series of criteria. At first, the President nominates the candidates for a vacant seat. Then, this member is ratified by the United States Senate. Specifically, these must fulfill the objective of representing the diverse interests of the country in terms of financing, agriculture, commerce and so on. The governors may not come from the same Federal Reserve District, and should serve for 14 years without the possibility of removing them by their political views. During this time, Chair, Vice Chair and the Vice Chair for Supervision of the Board serve as Board members for the
22 same 14 years and their positions for only 4 of them. Also, it is important to highlight that this organism has determined part of its election procedure to the Congress. For example, the Congress sets the salaries of the Board members (Federal Reserve, 2019). Furthermore, this implies a certain degree of politics involved on the selection process, beginning with the specific nomination as it is, which we will address on further paragraphs.
As stated before, this organism, for the Federal Reserve system and its functioning, is vital for the stability of all the macroeconomic and financial activities over the country. However, on recent years, there has been a lot of tension due to the conflict between the current President of the United States, President Donald Trump and the Federal Reserve. President Trump stated on Twitter that Jerome H. Powell, current chair of the Federal Reserve, might be a bigger enemy for the United States than China’s President, Xi Jinping, because the Fed has refused Trump’s demand to lower interest rates significantly (BBC, 2018). Of course, the lowering of interest rates is so substantial to the President considering that it implies economic growth through the lowering of financing costs, which means that, eventually, by the lowering of the interest rate, banks could lend more. Emphasizing, the President stated that the high cost of borrowing hurts the U.S. economy. Usually, a President pushes the central bank to lower the interest rates so that the rate of investment grows due to their inverse relation explained before on the basic macroeconomic equation. On the other hand, this is also explained by the Government trade war against China, which has caused the investment to fall down, since investors have lost their confidence due to the current political instability. In other words, President Trump wants to low interest rates, encouraging investment stopping the problem from expanding itself (BBC, 2018). On recent times, as stated before, Trump has criticized the FED by the decisions and statements they have emitted, even criticizing the current composition and leadership of the FED. As a matter of fact, the members of the Board of Governors are not as dovish as the President seems to want, some even argue that the next members to be nominated by the President will be involved with the current politics of the United States. However, this would eventually pose a threat to the stability of the institution and damaging the long term economy. (Forbes, 2018)
23 This tension between the FED and the President has been present several times throughout the history of the United States. A lot of examples could be introduced, however, in this study guide, we will focus on President Johnson example. All delegates are encouraged to make further investigation over the conflicts at hand and the historical frictions between this figures. In this case, President Johnson, during 1965, took Fed chair William McChesney Martin to the woodshed at his ranch to demand the FED to keep rates low. A year later, after winning the 1964 election, Johnson pursued fighting two wars: one on poverty, and one in Vietnam. Both needed government to make huge spending, so the government debt rose in a considerable way (CNBC, 2019). Of course, Martin saw all this additional spending as a formula for inflation, also fearing that he was not getting accurate information from the administration on their spending plans, he decided that raising interest rates was not the best move because it could generate higher inflation. Then again, when interest rates fall down, people start borrowing more money because they pay less when they borrow and save less due to the low returns they have from the banks. Since more money circulates in the economy and people have bigger disposal to buy, inflation rates can raise because there is more demand in the real and financial sectors.
Martin was well aware of the counter-cyclical mission of the Federal Reserve in order to anticipate and prevent recessions. He once said “The function of the Federal Reserve is to take away the punch bowl just as the party is getting good.” Martin began speaking publicly about his concerns. He was afraid the growing cost of the Vietnam War would force a devaluation of the dollar. This caused a relationship between them to go wrong (CNBC,2019). Indeed, Johnson and his successor managed to keep interest rates, leading to remarkable inflation over this period of time.
The conflict between the interest of political actors to enhance measures that accelerate the economy has been historically present in the United States. Which means, tension between political and appropriate economic measures has been present and probably will continue to risk the economic stability of the country. As delegates you are asked to enhance a proposal to this specific problematic so a proper manage of the economic structure and policies can be made.
24 TOPIC A: REEVALUATION OF FED COMPETENCES SUBTOPIC B: SHOULD PRIVATELY OWNED-BANKS LOSE THEIR SAY ON THE FEDERAL RESERVE BANKS STRUCTURE AND THE GOVERNMENT WIN MORE PROTAGONISM ON THE FED’S DECISIONS?
As the FED is currently composed, in each of its 12 branches across the country, a Board of Directors is the one in charge of supervising and developing that region’s policy. Each board has 9 directors, from which 3 are elected by the Board of Governors and the rest by member commercial banks, creating a majority by private-owned enterprises. This creates a private-public enterprise that takes some of the decisions away from government officials and gives commercial banks a big say on economic policy nationwide (Federal Reserve, 2019). In 1913, when the government of Woodrow Wilson signed the Federal Reserve Act, he and his economic advisors were pushing for more control of the government over the new entity, whilst the commercial banks were lobbying for greater stakes for the private sector. The dispute was settled by creating a system in which the FED, in its relatively independent character, had components of both. But recently, many argue that one of the main causes of the institutions’ inefficiency is that commercial banks often push for measures contrary to those suggested by the government in order to have a balanced economic policy (Kutlu & Al Masud, 2017). On the other hand, more presence of the government in the system could foster a greater level of political meddling with the country’s financial system. Whether that system is actually working has been debated for many years, and now it is your responsibility to settle the dispute.
One of the most remarkable economists of the twentieth century, Milton Friedman, argued that the way the FED was built was so ineffective, that more control of the government was needed in the institution in order for it to work. Although he also argued that to better control the demand and supply of money in the system the FED should ultimately replaced by computer programs. It would, he said, create many small mistakes, but overall would help to prevent major disasters (O´Toole, 1997). Another argument was that of democracy and representation, since people with power to create gigantic inflation or major recession are never elected democratically. Instead, leaving many of these decisions to widely
25 unchecked functionaries of private entities. Was it under Treasury’s control, bigger congressional oversight would take place. In any case, the independence of the FED has been put to the test many times, and not always has it been successfully upheld (Kane, 1974).
But a FED that goes along with plans by the president or congress might not always be a bad thing after all, after all, it is easier to govern if all branches are united in a common goal. In this case, an obedient central bank could mean a big deal in helping the executive to move his political agenda, thus facilitating the development of new policy and enabling the public to better predict the FED ́s future decision making. (Manabu Saeki, & Shull, 2003).
TOPIC A: REEVALUATION OF FED COMPETENCES OBJECTIVES
Your role as a delegate is to formulate new mechanisms that prevent political interest permeating the monetary policy adopted by the FED and the integrity of the system. As a matter of fact, this topic as a whole regards the reevaluation of the functional and organizational structure of the FED, having two subtopics that aim to be cases for you to consider how to approach this complex themathics. Currently, as stated several times throughout this guide, one of the functions of the FED is to maintain the inflation objective in line, while maintaining short and long stability. But, can the Board take the right decisions while being in constant pressure from the government? We are expecting from you delegates to bring into a debate these important topics, hence they represent important issues towards the economic stability of the country. Furthermore, we expect innovative ideas that can help overcome this historical problem that not only the central bank of the United States faces.
Namely, we expect from delegates: 1. Recognition of the current debate between a more governmentally controlled FED and the independence of it.
26 2. Comprehension of the consequences and effects, economically and politically wise, of a structural modification. 3. Creative solutions which regard, not only the basics of macroeconomic policy, but also the long term implementation of this accord. 4. Identification and solution of historical problems and their consequences such as the financial and economic crisis of 2008. 5. The creation of long term policy and strategy for the FED to keep up with changing banking trends and mechanisms.
TOPIC B: OPERATIVE CAPACITIES OF THE ORGANIZATION BRIEF DESCRIPTION OF THE TOPIC
As mentioned before, the politics adopted by the Federal Reserve of the United States have been the object of constant critics and have severely changed over time. The Great Depression in 1929 represented a key point in the role of monetary policy for controlling the negative effects crisis has over society. John Maynard Keynes, one of the greatest economists of this time, considered that the economy is best controlled by manipulating the demand for goods and services. As mentioned before, Keynesian economists believe in consumption, government expenditures and net exports to change the state of the economy. In the basic macroeconomic equation presented before it is possible to observe that when the Government expenditure (G) e is increase so will be the Gross Domestic Product (Y) in the short term. Simplified, Keynesian Economics (KE) focuses on using active government policy to manage aggregate demand in order to address or prevent economic recessions. According to the prior statement, KE defines a need for expenditure from the government in fields that could dynamize the economy and boost it towards growth. In times of crisis, Keynes even moved for deficit spending, that according to him, would reactivate the economy by bolstering the creation of jobs and so generating income that would be invested, even more so if interest rates are down because of low levels of expenditure. However, it should be noticed that the approach proposed by KE is based on fiscal policy rather than on monetary policy (Investopedia, 2019)
27 In fact, they establish that this variables in short term have an effect that can considerably increase the economical situation. For example, this is why in 1930 the Government of the United States invest a lot of resources in the construction of their roads (International Monetary Fund, 2019) For many years the capacities of the FED were drawn by these economic ideas and the policies adopted were based on fighting the depression. This caused the system to be more careful about the decisions it took and especially how the monetary policies were enforced to prevent crisis happen again.
Years later Milton Friedman completely changed the way monetary policy and financial regulation were driven in the country. The gradual victory of anti-regulatory, pro-market economic views on the west, particularly in the 1980s, Reagan-Thatcher period began a deregulatory trend that eventually included the financial sector. Initially, the results of implementing his pro-market prescriptions were largely positive. Excessive government regulation, particularly in more socialist economies, had, in fact, created a stranglehold on businesses – especially small to medium-sized – that was doing far more harm than good. The monetary policy objectives also changed a lot with the adoption of what is known as the monetarism promoted by Friedman (International Monetary Fund, 2019). Monetarists say that central banks are more powerful than the government because they control the money supply; in this sense, tools such as the economy intervention rate are proven to be sharper when addressing short economic recessions. Stimulus spending adds to the money supply, but it creates a deficit in the country’s sovereign debt. That will increase interest rates since it expands the supply function. Monetarists say that central banks are more powerful than the government because they control the money supply (International Monetary Fund, 2019).
Financial engineering became a new field of study and derivatives were developed in the beginning of the new century. Derivatives are basically bets, various types of bets. With derivatives, there are all sorts of bets speculators can make because derivatives can include bets on a company’s stock, commodities prices, the likelihood of a company’s bankruptcy, and even the weather. In the current financial system, it
28 is possible to make these bets on investments other than derivatives, although derivatives are special simply because their existence makes a pool of possible bets much larger. Although derivatives were dangerous to the stability of the financial system because of their risk, regulators allowed derivatives investing to be unregulated and even denied attempts to regulate them.
Monetarism and liberalization of the financial were highly predominant until the crisis of 2008 arrived. The excessive liberalization of the market allowed banks to create mechanisms to leverage their profits and create bubbles that can harm seriously the economy, especially the consumer confidence on the market. A great example is the CDO created by banks in the 2000 so they could lend more money and increase their profits without having the risk that lenders would not pay money back. This caused a lot of banks to borrow money from lenders, so they could buy a house artificially raising the prices of houses and creating an irresponsible way of managing the financial system. These were the principal causes of the 2008 crisis and generated a serious debate on the way in which the FED should behave.
In this order of ideas, it is important to discuss both topics that continue to be of high controversy. Therefore in the committee, it is propose take into consideration the liquidity trap and the measures that the FED can take to prevent a crisis such as the one presented in 2008. In other words, the committee must discuss and generate solutions, recognizing the tools that we currently have, for solving eventual turmoils.
TOPIC B: OPERATIVE CAPACITIES OF THE ORGANIZATION HISTORY OF THE TOPIC
Historically, the Fed has taken action against the several financial turmoils of the nation. Notably, the FOMC has cut the the fed fund rates to almost zero in December 2008. At the same time, this was combined with two rounds of quantitative easing through the large scale purchases
29 of mortgage-backed and U.S. Treasury securities from November 2008 to March 2010 and from November 2010 to June 2011. Formally, this questioned the policy of the Federal Reserve, considering that they moved from their accommodative policy and needed their balance sheets stabilized. As said before, the composition of the FOMC regards both the public and independent or private factions of the central bank, having both members of the Board of Governors and the Reserve Bank presidents (Kansas Fed, 2012). Up until this point, delegates would have noticed that the issue at hand on this topic is the different actions that the Fed and the FOMC could eventually take. The different turmoils of the US., explained throughout the entirety of this document, have showed the massive capacities of response of this central bank.
Later on, during 2011, the U.S. Congress considered eliminating the Reserve Bank presidential votes to ones confirmed by the Senate. Only a year later, in 2012, the Sen, Bernie Sanders proposed a bill to remove bankers from the regional reserve banks (Kansas FED, 2012). In that sense, the context has been described and the committee, considering the historical use of it tools, has been explained formally. In consequence, delegates must consider both issues, committee tools and historical context, in order to tackle the issues at hand explained on what follows.
TOPIC B: OPERATIVE CAPACITIES OF THE ORGANIZATION SUBTOPIC A: LIQUIDITY TRAP OR HIGHER INFLATION RATES
The global financial crisis of 2008-09 ushered in the worst recession in advanced economies since the 1930s. Central banks initially responded by reducing policy interest rates sharply. Soon these rates approached zero, raising the specter of a liquidity trap – the point at which further conventional monetary expansion becomes impossible. It was considered because of this trap that interest rate can`t go below zero but negative interest rates were brought into the mix later, as some central banks probed just how low their policy rates could safely and effectively go (Ball, Gagnon, Honohan, & Krogstrup, 2019).
30 The measures that have been taken by the different central banks, including the Federal Reserve, were not strong enough to reduce the negative effects of the crisis. Recovery has been slow compared to recoveries from past deep recessions; eight years after the crisis, much of the world is still far from full employment. There are more actions that central banks can do to stimulate economic growth and inflation, such as higher monetary emission. Furthermore, there are policy options available that could reduce the likelihood of hitting zero again in the future. The low level to which the neutral real interest rate has trended and the low inflation targets of central banks, which together imply that nominal interest rates will be chronically low and central banks’ ability to reduce rates in downturns will be sharply limited.
To talk about this, it is really important to consider several macroeconomic facts. First, it is possible to move nominal short-term policy rates into negative territory, thereby loosening monetary policy further through standard means. Several central banks have pushed policy rates below zero, and these negative rates have transmitted to domestic asset prices and the exchange rate in much the same way as cuts in policy rates have done when they were still positive. Secondly, the banks have a wide range of options through Quantitative Easing (Ball, Gagnon, Honohan, & Krogstrup, 2019). These programs have already had substantial effects on the countries that implemented them. In the US bonds had a huge impact had macroeconomic effects equivalent to those of a sustained reduction of about 200 to 250 basis points in the policy rate. Finally, the use of a more expansive monetary policy. Although policymakers have tools for stimulus at the lower bound, full employment would be more secure if policy frameworks were adjusted to reduce or eliminate the likelihood that nominal rates hit zero. The most obvious of such adjustments would be a modest increase in central banks’ inflation targets.
This creates a debate in the future monetary policies that the FED should adopt. Several economists argue that it is highly possible that in the near future countries have a slowdown on their economic growth. This scenario surely will affect the economy of the United States and will force the interest rate near or below zero. As delegates, we expect you to analyze what should be the best decisions that FED could make in the possible future for facing this problem.
31 TOPIC B: OPERATIVE CAPACITIES OF THE ORGANIZATION SUBTOPIC B: REGULATION OF THE FINANCIAL MARKETS
Regulation of the financial markets has been a topic of several discussions in the United States. There are two basic approaches when talking about financial regulations, the first one is the one that follows Friedman’s ideas of leaving the financial market regulated themselves and therefore the regulation FED should have with these markets must be as low as possible. On the other hand, there are some economists that consider the financial market should be regulated because people don’t behave completely rational all the time since they make huge mistakes. This idea can be clearly seen with the statement of Thomas Sowell, one of the most important economists of all times “It is hard to imagine a more stupid or dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong”. There are economists that strongly believe markets should be more regulated establish that people in good times tend to make risky decisions that could create serious economic problems and could leave them without funds (Krugman & Wells, 2018).
A key point to understand the current financial problems is with the Garn- St. Germain Depository Institutions Act passed by Congress in 1982. This act promoted by president Reagan deregulated banking by removing restrictions on loans for savings and loan banks. Reagan’s budget cut also reduced regulatory staff at the Federal Home Loan Bank Board. This created an impressive growth in the financial system that made people believe this massive deregulation was good. Banks start investing in risky real estate ventures. Reagan’s deregulation and budget cuts contributed to the savings and loan crisis of 1989. The crisis ushered in the 1990 recession. Furthermore, the “Great Moderation”—years of low inflation and stable growth fostered complacency and risk-taking. The folly of the financiers started, the years before the crisis saw a flood of irresponsible mortgage lending in America. Loans were doled out to “subprime” borrowers with poor credit histories who struggled to repay them. These risky mortgages were passed on to financial engineers at the big banks, who turned them into supposedly low-risk securities by putting large numbers of them together in pools. These pooled mortgages were used
32 to back securities called “Collateralized debt obligations”, which were sliced into tranches by a degree of exposure to default. Investors bought the safer tranches because they trusted the triple-A credit ratings assigned by agencies such as Moody’s and Standard & Poor. The agencies were paid by, and so beholden to, the banks that created the CDOs. Investors sought out these securitized products because they appeared to be relatively safe while providing higher returns in a world of low-interest rates.
The arguments of big banks concerning the cities independency of property markets proved wrong, starting in 2006 America suffered a nationwide house-price slump. The start of the financial crisis could not be prevented and America started suffering different problems that even today are still occurring. Chain reaction exposed fragilities in the financial system. Pooling and other clever financial engineering did not provide investors with the promised protection. Mortgage-backed securities slumped in value if they could be valued at all. Trust in the market fall and people reduce considerable their investments in order to be safe from the crisis. The consequences of 2008 can be still seen today and it is important to discuss the role of the Federal reserve within the prevention of crisis. It is important to point out that the Senate plays also a big role with in the regulation of the Financial Market and that it differentiate from the regulation that the Federal Reserve does. In this order of ideas, we ask you, delegates, to focus on whether should keep the liberalization present since the Reagan administration or what kind of new regulation should be implemented.
TOPIC B: OPERATIVE CAPACITIES OF THE ORGANIZATION OBJECTIVES
In this order of ideas, the main objectives of this topic are:
* Analyze what should be the best decisions that FED could make in the possible future for facing the liquidity trap
33 * Focus on whether should keep the liberalization present since the Reagan administration or what kind of new regulation should be implemented.
SPECIFICS ON PROCEDURE
The Federal Reserve Act was the constitutive piece of legislation of the central bank of the United States in its current form, signed into law on December 23, 1913. Under his “New Freedom” campaign platform for the 1912 presidential elections, Woodrow Wilson assured the american public that measures would be taken to avoid the repetition of financial crises of the scale of the 1907 Panic. And so, the FED was born. And specific tools were given to it in order to promote national economic goals. Specially, three main mechanisms: open market operations, the discount rate and reserve requirements. While the Board of Directors is responsible for the last two, the Federal Open Market Committee is in charge of all open market operations. Combining the three, the FED tilts the demand and supply of balances that depository institutions hold at Federal Reserve Banks a so it alters the federal funds rate. This change affects short term interest rates, foreign exchange rates and several other economic and social variables, such as unemployment or price levels.
The Federal Open Market Committee (FOMC) counts with twelve members. From these twelve, four have a yearly rotation and are presidents of Federal Reserve Banks. The president of the New York FED Bank is a permanent member of the FOMC, and the other seven spots in the Committee are destined for the members of the Board of Directors. (The Federal Reserve, 2020).
At the same time, the FOMC issues directives to the Federal Open market desk, engaging in trades that effectively move the interest rates to the prescribed target. Until 2014, this target was set at zero, implying a series of effects for both the private and public sector. Of course, this is the Fed’s most important tool. However, there are decisions, such as lending to an institution, that regard specifically to the Board of Governors.
34 In that sense, it is important to highlight that delegates will be having, as tools of the committee, the ones previously described as the FOMC ones. However, delegates could eventually use tools coming from the Board of Governors or the Reserve Banks, since its members are present on the committee.
Specifically, the committee will be constantly emitting documents for both topics. Nevertheless, even if delegates could eventually make use of the tools of the Board of Governors or the Reserve Banks, this committee will mostly focus on the decision-making process of the FOMC for solving the situations that the committee will be constantly having. But, clearly, will need the help of the rest of the institutions of the Federal Reserve System to formally address the topics and subtopics. For this, the committee will have a document called “Issue Directive”. This will be composed as follows:
Example:
Issue Directive # Topic or name: Quantitative Easing now. Project Leader: Alan Greenspan
The US FED has: (Preambulatory clauses with context of the situation) Considers the needs for stabilizing the market since the 2008 crisis affected the US Economy. Evaluates the economic theories of Milton Friedman.
Decides: Increase the interest rate on a 0,2 percent, in order to gain more confidence and trust. Modify the internal structure of the FED Reserve Banks, adding 3 members of the Congress to its meetings on a regular basis.
Signing leaders: (As an annex) Being reunited from the 22 to the 25 of March of 2020. Washington, Eccles Building.
35 QARMAS
1. Should a financial crisis result from current political turmoil, would the FED be able to enact effective measures to normalize the crisis?
2. Shall the FED take into consideration adopting in future scenarios negative interest rates to face the decreasing inflation rates?
3. Which new mechanism can the organization take in order to face the world economic slowdown and the negative consequences emerged from the trade war with China?
GUIDING QUESTIONS
1. What has done the FED in the past towards this problematic?
2. What have been the principal changes adopted by the FED?
3. What are the main competences that should be changed?
4. What is the position of your character towards the topics?
5. Does the current composition of the FED allow it to be independent enough? Should the FED be reconstructed in order to favor better policy making?
36 REFERENCES
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38 Milton Friedman – Abolish The Fed Archived June 11, 2015, at the Wayback
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