1.1 Congress Established the First Bank of the United States in 1791 with a 20-Year Charter

1.1 Congress established the first Bank of the United States in 1791 with a 20-year charter. When the charter expired in 1811, Congress did not renew it. In 1816, Congress established the second Bank of the United States, again with a 20-year charter. In 1832, President Andrew Jackson vetoed an act to extend the charter.

1.2 Congress split the Federal Reserve System into 12 districts in an attempt to decentralize the system rather than having a single central bank based in Washington, DC. In practice, however, the Fed is centralized with power concentrated in the Board of Governors and the Federal Open Market Committee.

1.3 During normal times, the Federal Open Market Committee is probably the more important body because it directs open market operations and sets the target for the federal funds rate. However, during the financial crisis, the Fed needed to make decisions rapidly and use new policy tools. During that period, certain members of the Board of Governors (part of the “four musketeers”) became more important than the Federal Open Market Committee. Additionally, the Board of Governors plays a larger role than the Federal Open Market Committee in maintaining the stability of financial markets and institutions.

1.4 The Dodd-Frank Act is legislation passed during 2010 that was intended to reform the regulation of the financial system. The provisions of the bill relevant to the Fed make only relatively minor changes to the system’s operation. The changes include: 1. Barring class A directors of the Federal Reserve banks from participating in the election of bank presidents

2. Making the Fed a member of the new Financial Stability Oversight Council

3. Designating a Fed vice chairman for regulatory supervision,

4. Ordering the Government Accountability Office to audit the emergency lending programs the Fed carried out during the financial crisis

5. Requiring the Fed to be more transparent about the parties to whom it lends and with whom it buys and sells securities

6. Establishing the Consumer Financial Protection Bureau, which took over some of the Fed’s responsibilities for administering consumer protection statutes that apply to all financial firms.

1.5 Congress passed the Federal Reserve Act in order to deal with recurring financial panics. The severity of the Panic of 1907 greatly increased support among the public and in Congress for creating a central bank. 1.6 Congress wanted the member banks to own the Federal Reserve banks in order to divide economic power within the Federal Reserve System among bankers and businesses interests, among states and regions, and between government and the private sector. Member banks own shares in the Federal Reserve banks but do not have the rights typically granted to shareholders. To the extent that member banks have very little influence over Federal Reserve policy, Congress did not achieve its goal.

2.1 The president can exercise control over the membership of the Board of Governors and appoint a new chairman every four years, and the Congress can amend the Fed’s charter and powers or even abolish it entirely.

2.2 The public interest view is a theory of central bank decision making that holds that officials act in the best interest of the public. The principal-agent view is a theory of central bank decision making that holds that officials maximize their personal well-being rather than that of the general public. The political business cycle is the theory that policymakers running for reelection will urge the Fed to lower interest rates to stimulate the economy prior to an election. If the Fed is more concerned with preserving its power, influence, and prestige, as the principal- agent view holds, then it would be more likely to take actions resulting in a political business cycle as it attempts to avoid conflict with groups that could limit its power and influence.

2.3 The main argument for Fed independence is that monetary policy is too important to be left to politicians, who are not economists and have their own political interests at stake, not just the long-run interest of the economy. Arguments against Fed independence include the view that elected officials should make monetary policy to ensure direct control by the people, and not control by appointed officials who do not face election.

3.1 Among the Federal Reserve, the European Central Bank (ECB), the Bank of England, and the Bank of Japan, the length of terms of office are longest for the central bank board members of the Federal Reserve and shortest for the head of the Federal Reserve (the chairman). The Fed has the shortest length of term for its head, at 4 years, and the longest length of terms for its board members, at 14 years.

3.2 Less independent central banks tend to lead to higher inflation. An independent central bank can more freely focus on keeping inflation low.

3.3 The European Central Bank (ECB) has an executive board of six members, with one of the members serving as president. The board members are appointed by the heads of state and government, based on the recommendation of the council of Ministers of Economics and Finance after consulting the European Parliament and the Governing Council of the ECB. The governance of the ECB also includes the governors of each of the member national central banks. The decentralized organization of the ECB with the governors of the national central banks holding a majority of the votes, instead of the executive board, may make it harder to achieve a consensus during a crisis. During the financial crisis of 2007-2009, the ECB encountered difficulty conducting a common monetary policy for countries experiencing significantly different economic conditions. During the subsequent sovereign debt crisis, the ECB faced the dilemma of whether to buy the sovereign debt of struggling governments so that the governments would still be able to raise funds by selling bonds. The ECB bond purchases would also serve to protect the solvency of European banks with large holdings of government bonds. But the ECB bond purchases risk raising expectations of higher future inflation and more moral hazard in government budgetary policies. 3.4 Low-income (less-developed) countries often have more trouble selling governmental debt to investors than do high-income countries. As a result, it is often difficult for a central bank to act independently in a less-developed country. When the government of a less-developed country runs a deficit, the country’s central bank is often under great pressure to buy some, or even all, of the bonds the government must issue to fund the deficit. Research has shown that the more independent a central bank is, the lower the inflation rate will be. On these grounds, we would expect the average inflation rate in low-income countries to be higher than in high-income countries.