comparing/contrasting Central Banks

Central Banks : More than Managing Money in the Changing World

Central banks are banks administered by a national government and it issues money and carries out the country 's monetary policy (Wall Street Words , 2003 . This is the reason why it is important that every country in the world must have a central bank , or share one (for example , in the French African Community . In the United States , it is called the Federal Reserve , in the UK the Bank of England , in Germany the Bundesbank and in Japan the Bank of Japan . Central

banks stand uncomfortably at the point where fiscal policy and monetary control meet , ensuring that the government has the finances to meet its bills and serving the public debt that results

The Bloomsbury Guide to Human Thought had lain bare that central banks have little or no control of fiscal policy but they do operate monetary policy and oversee the financial system . In fact , the role of the central bank may be divided into four areas

(1 ) As banker to the government

Public expenditure on goods and services typically accounts for 40 of gross domestic product (and more if transfer payments are included . A government deposits its revenues and reserve currencies with the central bank and pays its bills with central bank cheques . The central bank typically charges the government a fee for acting as its bank : this is one of its major sources of revenue

(2 ) As banker to the banks

The central bank takes deposits from banks and lends to them . This function helps the central bank to control the supply of money , but also helps it to maintain the stability of the financial system . The central bank acts as lender of last resort , that is , it stands ready to provide any bank with cash should it be in difficulty , or if its customers want to withdraw their deposits . This safety net enables banks to borrow short and lend long , without losing sleep over it . Often central banks control bank lending by setting a fixed proportion of deposits that must be deposited at the central bank

(3 ) As supervisor of the banks

Central banks usually have a say over who can operate as a bank or take the public 's deposits . They regularly check the banks ' balance sheets and , either by law or by gentle persuasion , force financial institutions to toe the line

(4 ) Issuing currency , and offering a guiding hand in foreign exchange markets

Designing , printing , issuing and withdrawing notes (and often coins as well ) is the job of the central bank . In consultation with the government , and with other central banks , the central bank intervenes in currency markets to smooth fluctuation or to protect a target value Central banks can also nudge currencies either way by shifting interest rates up or down relative to those prevailing in other countries

Throughout history , central banking traces its roots way back in the seventeenth century (De Kock 1974 ,

.1-17 . The oldest central bank is the Swedish Riksbank , which was formed in 1668 and the next oldest , the Bank of England , was formed in 1694 . However , central banking only began to emerge more widely in the early nineteenth century . For example , the Bank of France was founded in 1800 , the Bank of the Netherlands in 1814 the National Bank of Austria and the Bank of Norway both in 1816 , and the forerunners of the Danish National Bank and the Bank of Spain in 1818 and 1829 respectively . The next wave of central bank formation came in the late nineteenth and early twentieth centuries . The Bank of Russia was created in 1860 , the German Reichsbank in 1875 , the Bank of Japan in 1882 , the Bank of Italy in 1893 , the Swiss National Bank in 1905 and the US Federal Reserve System in 1914 . In fact , though , it was only in the aftermath of the First World War and , in particular , as a result of the International Financial Conference in Brussels in 1920 that central banking came to be considered as an essential element of statehood (De Kock 1974 ,

. 9 . Consequently , there followed a worldwide move towards central banking in many former British colonies , such as South Africa (1921 , Australia (1924 , New Zealand (1933 , Canada (1935 ) and Ireland (1942 , as well as in many South American countries , including Peru (1922 , Colombia (1923 , Chile (1926 , Ecuador (1927 , Bolivia (1928 and Argentina (1935 , and more generally thereafter in newly-independent states such as Pakistan (1948 , Israel (1954 , Morocco (1959 , Kenya Tanzania and Uganda (all in 1966 . Currenty , then , even though there is still some debate as to whether a central bank is a necessary component of a sound economic system (Goodhart , 1991 , it is apparent that in practice central banking is an almost ubiquitous phenomenon (Elgie Thompson , 1998 ,

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However , modern central banks have one thing in common all over the world . These national banks leans on an interest in financial stability as a public policy objective , as a key factor influencing macroeconomic performance and the potential for systemic disturbances . However , the precise institutional arrangements vary widely country by country , and are also changing rapidly in many cases

United States Central Bank

The United States ' central bank consists of 12 banks whose policies are coordinated by the Federal Board of Governors . The 12 Federal Reserve Banks accommodate the geographic size and economic diversity of the United States and the nation 's large number of commercial banks and thrifts . In Figure 1 , a location map the 12 Federal Reserve Banks is provided and the colors indicate the district that each serves . These banks implement the basic policy of the Board of Governors . The Federal Reserve Bank in New York City conducts most of the Fed 's open-market operations

Figure 1 . The 12 US Federal Reserve Districts . Source : Federal Reserve Bulletin

The Federal Reserve System divides the United States into 12 districts each having one central bank and in some instances one or more branches of the central bank . Hawaii and Alaska are included in the twelfth district . The Federal Reserve Act of 1913 created the Fed , which serves as the central bank of the United States . The Federal Reserve System sought to stabilize the banking industry through regulations developed and imposed by the seven member board . The president , with Senate confirmation , appoints board members to fourteen-year terms . The chairperson of the Fed , also appointed by the president with Senate approval , serves a four-year term . Board members are removable only by impeachment resulting from the commission of a criminal act . They may not be removed over a disagreement about economic policy options with either the president or the Congress . The Fed is therefore a stable independent , and powerful force in economic policy . The most important governing body of the Federal Reserve System in setting monetary policy is the Federal Open Market Committee (FOMC , which is composed of the seven-member Board of Governors (including the Chairman of the Board who is also the Chairman of the Committee , the President of the Federal Reserve Bank of New York (who is also the Vice-Chairman of the Committee , and the Presidents of four other Federal Reserve Banks , who serve on a one-year rotating term . Since 1982 , the FOMC normally meets eight times a year in Washington , DC , although the Committee may have also teleconferences in addition to the regularly scheduled meeting

From the outset , each Federal Reserve Bank purchased , for its own account , both Treasury securities and bankers acceptances (BAs . These decentralized open-market purchases were executed more as a source of revenue rather than as a tool for regulating reserves to control the money supply in each Federal Reserve district . Discount rate changes which had to be approved by the Board in Washington , were the main instrument to vary credit availability , with the typical result that discount rates varied from one Federal Reserve district to another Starting in the early 1920s , Benjamin Strong , the influential Governor of the New York Federal Reserve Bank , argued that open-market operations could be used to stabilize the economy , but that they had to be coordinated among the regional Reserve Banks and executed by the New York Federal Reserve Bank . This led to the creation in 1923 of the Open Market Investment Committee (OMIC , later FOMC , consisting of the Governors of the Federal Reserve Banks of New York , Boston Philadelphia , Cleveland , and Chicago , thus excluding the Governors of the other seven Federal Reserve Banks and the members of the Federal Reserve Board in Washington . However , this Committee , chaired by Strong himself , did not have the exclusive power to approve the open market operations of the regional Federal Reserve Banks . The Trading Desk at the New York Fed simply carried out operations for all the Federal Reserve Banks , including the New York Federal Reserve Bank

As an independent agency , the Fed is free to pursue monetary policies that may not find support either from the president or from Congress The Fed has demonstrated a willingness to raise interest rates in to cool ' the economy and reduce inflationary pressures even if the White House did not support this action

A primary goal of the Fed is to regulate the economy through control of the money supply . The currency in circulation today does not represent reserves of gold or silver held by the U .S . Treasury Department . The words Federal Reserve Note ' on currency reflect a departure from the reliance on these metals , a change from the Silver Certificate ' of years past . The supply and value of money in circulation is independent of gold and silver . The Fed has both the power and the responsibility to control the supply of money in circulation . Increasing the supply of money drives down interest rates and stimulates demand and economic expansion (with the risk of inflation . Decreasing the supply of money drives up interest rates reduces demand , and cools the economy down (with the risk of higher unemployment rates

Thus , when the economy is in recession , monetary policies usually aim at encouraging people to spend money . Lower interest rates and increased availability of money accomplish this goal . The Federal Reserve Board oversees the operation of banks participating in the Federal Reserve System and assists them by serving as a clearinghouse for banking transactions and by lending them money . The Federal Reserve Board also has the power to buy up government bonds held by investors . These are open market operations

Central Bank of Denmark

In Denmark , the Danmarks Nationalbank is responsible for monetary policy . Danmarks Nationalbank conducts monetary policy by setting the monetary-policy interest rates , like the discount rate , the current-account rate and the lending rate (equal to the rate of interest for certificates of deposit . The Board of Governors of Danmarks Nationalbank determines the interest rates and they could change these as required at any time . Danmarks Nationalbank 's interest rates guide the short-term interest rates in the Danish money market , as well as the deposit and lending rates that the banks offer customers

Denmark adopted a fixed-exchange-rate policy , which is based on the Euro area . This means that the aim of monetary and foreign-exchange policy is to keep the krone stable vis-a-vis the euro . The main objective of the monetary policy in the Euro area is to maintain price stability , i .e . to avoid inflation . By keeping the krone stable vis-a-vis the euro , a basis for low inflation is also created in Denmark . Danmarks Nationalbank can influence the krone rate by adjusting its monetary-policy interest rates . When Danmarks Nationalbank increases its interest rates relative to the interest rates of the European Central Bank (ECB , the krone will have a tendency to strengthen . When , on the other hand , Danmarks Nationalbank lowers its interest rates relative to the interest rates of the ECB , the krone will have a tendency to weaken

In the short term , Danmarks Nationalbank can stabilize the krone by buying and selling foreign currency in the market . When Danmarks Nationalbank sells foreign currency (and buys kroner , the krone will have a tendency to strengthen . When Danmarks Nationalbank buys foreign currency (and sells kroner , the krone will have a tendency to weaken Danmarks Nationalbank is a member of the National Central Banks (NCBs refer to the three EU national central banks of the Member States that have not adopted the single currency : United Kingdom , Sweden and Denmark . These NCBs carry out operations that form part of the tasks of the Eurosystem . Whereas the principle of decentralization applies to operations only (e .g . the basic open-market operations , called the `main refinancing operations , are executed by each NCB with the credit institutions located on its national territory , the monetary policy decisions remain centralized (e .g . the interest rate of the main refinancing operations is decided by the ECB Governing Council and the overall amount of short-term liquidity provided each week to the credit institutions in the Eurosystem is decided by the ECB Executive Board This principle is very similar to the one that was applied to the allocation of responsibilities and functions between the Central Bank Council /Directorate of the pre-euro Bundesbank and the Land Central Banks

A General Council , composed of the President and Vice-President of the ECB and the Governors of the 15 EU National Central Banks , has been established for the transition period when some national central banks of the ESCB do not participate in the Eurosystem . The General Council coordinates monetary policies between the Eurosystem and the `out ' NCBs (which retain their powers in the field of monetary policy , which has to be consistent with the goal of price stability , cooperates on issues dealing with prudential supervision of credit institutions in the European Union , and contributes in the preparations for irrevocably fixing the exchange rates of the euro against the currencies of the `out ' Member States that have made a formal request to join the eurozone (Apel , 2003 ,

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When the other three current EU Member States (Denmark , Sweden and the United Kingdom ) eventually join the eurozone , the Governing Council will be composed of 21 members , with the NCB governors effectively holding 71 per cent of the votes in that decision-making body of the Eurosystem This is in contrast to the case of the pre-euro Deutsche Bundesbank where the Presidents of the Land Central Banks held only 53 per cent of the votes in the Central Bank Council , and to the case of the US Federal Reserve System where the five voting Presidents of the district Federal Reserve Banks hold only 42 per cent of the votes of the Federal Open Market Committee , the decision-making body of the US central banks . In a Eurosytem composed of the 15 National Central Banks - and many more in the future , with the enlargement of the EU - the Executive Board (the center ) will clearly be in the minority with six votes out of a 21 . The `executive ' of the Eurosystem is relatively less important than the `executive ' of either the Directorate of the pre-euro Bundesbank or the Board of Governors of the Federal Reserve System

In Denmark , the government decided to hold a referendum on 28 September 2000 on whether it should abrogate its 1992 decision to retain its national currency . In this latest referendum , the people of Denmark rejected joining the eurozone by a 53 per cent majority . This result does not exclude the possibility of another referendum at some future date . In fact , with the successful changeover to the euro banknotes and coins in the eurozone at the beginning of 2002 , combined with the election of a new centre-right Danish government in late 2001 , the new government has indicated that another referendum on the euro may take place in early 2003 . With a majority voting in favor of the euro Denmark could join the eurozone soon thereafter , since the Danish krone has participated in ERM II since 1999 and its national central bank already satisfies the independence requirements of the `Treaty

The krone foreign-exchange market is the market for purchase and sale of foreign exchange against Danish kroner . The foreign-exchange market is central to the monetary and foreign-exchange policy since this is the market where the krone rate is formed and Danmarks Nationalbank intervenes by buying and selling foreign exchange . In the short term Danmarks Nationalbank can stabilize the krone by buying and selling foreign currency in the market . When Danmarks Nationalbank sells foreign currency (and buys kroner , the krone will tend to strengthen . When Danmarks Nationalbank buys foreign currency (and sells kroner , the krone will tend to weaken . The formal framework for the Danish fixed-exchange-rate policy is the European Exchange Rate Mechanism (ERM II . Denmark participates in ERM II with a central rate of kr . 746 .038 per 100 euro

Conclusion

The European Central Bank Governing Council uses neither a pure `monetary targeting ' nor a pure `inflation-targeting ' strategy to achieve and maintain its primary objective of price stability . It decided to use a combination of both strategies , which it called a monetary policy strategy based on `two pillars . In that sense , the ECB is more like the Fed . The FOMC 's monetary policy strategy , which has evolved over time , uses a combination of both of these strategies to achieve not one , but two objectives , namely price stability , which has never been numerically defined , and a sustainable growth rate of output which presumably means a growth rate of aggregate demand equal to the potential growth rate of output

Thus , central banks are concerned primarily with liquidity to ensure that they have the cash and flexibility needed to protect their countries ' currencies . The mix of currencies in a country 's reserves is based on its major intervention currencies - that is , the currencies in which the country trades the most . The degree to which a central bank actively manages its reserves to earn a profit varies by country

Works Cited

Apel , Emmanuel . Central Banking Systems Compared : The ECB , the Pre-Euro Bundesbank , and the Federal Reserve System . New York : Routledge , 2003

Bank for International Settlements Website . Acquired online at 13 August 2006 HYPERLINK "http /www .bis .org /cbanks .htm http /www .bis .org /cbanks .htm

Central Bank . Bloomsbury Guide to Human Thought . London : Bloomsbury Publishing Ltd , 2003

Central Bank . Wall Street Words (2003 . Retrieved 13 August 2006 , from xreferplus . HYPERLINK "http /www .xreferplus .com /entry /4708543 http /www .xreferplus .com /entry /4708543

Danmarks Nationalbank Website . Acquired online at 13 August 2006 http /www .nationalbanken .dk /dnuk /specialdocuments .nsf

Elgie , Robert , and Helen Thompson . The Politics of Central Banks London : Routledge

US Federal Reserve Board Website . Acquired online at 13 August 2006 HYPERLINK "http /www .federalreserve .gov /policy .htm http /www .federalreserve .gov /policy .htm

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