The Design and Role of Central Banks in the Global Economy.

The Design The Design and Role of and Role of

Central Central Banks in the Banks in the

Global Global EconomyEconomy

European European Central BankCentral Bank

EU PopulationEU Population

made up of 27 countries made up of 27 countries

Economic OutputEconomic Output

Euro Area: 16 Euro Area: 16 countriescountries

ObjectivesObjectives

ECB Shareholders ECB Shareholders Shares are attributed according to the population and GDP of each country

Euro Area: 16 Euro Area: 16 countriescountries

EMUEMUEconomic and Economic and

Monetary UnionMonetary Union

Union where several countries have the same:Union where several countries have the same:•Central Bank ECBCentral Bank ECB•Currency Currency •Monetary policyMonetary policy

Convergence Criteria Convergence Criteria

Substantial pricesSubstantial prices: the inflation must not be more : the inflation must not be more than 1.5 % higher than the three members with the than 1.5 % higher than the three members with the lowest inflation.lowest inflation.

Substantial exchange rateSubstantial exchange rate: the exchange rate has : the exchange rate has to be stabile relative other EU-currencies for two to be stabile relative other EU-currencies for two years before entering the EMU.years before entering the EMU.

Government financeGovernment finance: : - - Annual government deficitAnnual government deficit: the ratio of the : the ratio of the government deficit to the GDP must not exceed 3% at government deficit to the GDP must not exceed 3% at the end of the preceding fiscal year.the end of the preceding fiscal year.- - Government debt: Government debt: the government debt must the government debt must not exceed 60% of the GDP at the end of the not exceed 60% of the GDP at the end of the preceding fiscal year. preceding fiscal year.

Long-term interest ratesLong-term interest rates:: the nominal long-term the nominal long-term interest rates must not be more than 2 percentage interest rates must not be more than 2 percentage points higher than the three lowest inflation member points higher than the three lowest inflation member states. states.

Why have Sweden chosen not to Why have Sweden chosen not to be a member of the EMU?be a member of the EMU?

Election 14th of September 2003, Election 14th of September 2003,

55,9% voted against and 42,0% voted for.55,9% voted against and 42,0% voted for.

- Sweden is the most democratic country- Sweden is the most democratic country

in the world and will never join EMU in the world and will never join EMU without a vote from the Swedish people.without a vote from the Swedish people.

No incentive to change currencyNo incentive to change currency

- Sweden’s floating exchange rate has - Sweden’s floating exchange rate has apperaed to gain the Swedish economy for apperaed to gain the Swedish economy for the last 15 years.the last 15 years.

Reasons for Sweden to stay Reasons for Sweden to stay out of EMUout of EMU

1.1. Sweden would lose its ability to use Sweden would lose its ability to use monetary policy to prevent inflation and monetary policy to prevent inflation and unemploymentunemployment

2.2. Sweden is a relatively small country and Sweden is a relatively small country and will not be a priority for ECB. ECB would will not be a priority for ECB. ECB would use meassures to benefit the larger states use meassures to benefit the larger states and there meassures do not necessarily and there meassures do not necessarily have to benefit Sweden. have to benefit Sweden.

Reasons for Sweden to stay Reasons for Sweden to stay out of EMUout of EMU

3.3. Limited influence – when EMU reaches 22 Limited influence – when EMU reaches 22 members they will divide them into three members they will divide them into three groups with different number of votes.groups with different number of votes.

4.4. A membership in the EMU would mean that A membership in the EMU would mean that the monetary policy would fall outside the the monetary policy would fall outside the control of the government and hence the control of the government and hence the democratic control democratic control

independence would be transferred from independence would be transferred from the citizens’ level to an EU-level. the citizens’ level to an EU-level.

ConclusionConclusion

One single currency cannot suit as many as 16 One single currency cannot suit as many as 16 countries with different backgrounds and countries with different backgrounds and conditions an make them all gain conditions an make them all gain

the bigger and more powerful a country is the bigger and more powerful a country is the more it would benefit from a the more it would benefit from a membership of the EMU.membership of the EMU.

Swedish kronaSwedish kronaA proof that a non-membership of the EMU has gained Sweden is the fact that the Swedish krona has had the best development among all EU-currencies including the euro this year.

The United States’ Central Bank

Also known as: The Federal Reserve System

Or“The Fed”

DevelopmentDevelopment

U.S. had two central banksU.S. had two central banks

Failed and discontinuedFailed and discontinued

Continuing crises led to a need for a central Continuing crises led to a need for a central bank of sortsbank of sorts

The Federal Reserve System implemented in The Federal Reserve System implemented in 19131913

PurposePurpose

““to provide the nation with a safer, more to provide the nation with a safer, more flexible, and more stable monetary and flexible, and more stable monetary and financial system. Over the years, its role in financial system. Over the years, its role in banking and the economy has expanded”banking and the economy has expanded”

Act as the Government’s bank as well as other Act as the Government’s bank as well as other very large banksvery large banks

Use Monetary policy to control: money supply, Use Monetary policy to control: money supply, inflation, etc.inflation, etc.

Regulate transactions between regions Regulate transactions between regions

StructureStructure

There are 12 branches of the Fed spread out There are 12 branches of the Fed spread out in 12 major citiesin 12 major cities

The Fed is run by the Board of GovernorsThe Fed is run by the Board of Governors

Ben Bernanke is the chairman of the BoardBen Bernanke is the chairman of the Board

Most of the time, people simply agree with Most of the time, people simply agree with the Chairmanthe Chairman

StructureStructure

The Board of Governors has a sub The Board of Governors has a sub committee called the Federal Open Market committee called the Federal Open Market Committee, which also has the head of the Committee, which also has the head of the New York branch.New York branch.

Both are advised by:Both are advised by: Federal Advisory CouncilFederal Advisory Council Consumer Advisory CouncilConsumer Advisory Council Thrift Institutions Advisory CouncilThrift Institutions Advisory Council

PoliciesPolicies

Monetary PolicyMonetary Policy Carried out by changing interest rates and Carried out by changing interest rates and

influencing money supplyinfluencing money supply

Quantitative PolicyQuantitative Policy Done in times of extreme crisis where the Fed Done in times of extreme crisis where the Fed

buys bonds from corporationsbuys bonds from corporations

The FedThe Fed

In Essence, The Fed’s basic purpose is to In Essence, The Fed’s basic purpose is to help the U.S. stay stable, keep the economy help the U.S. stay stable, keep the economy strong internationally, and avert or end strong internationally, and avert or end bank panics.bank panics.

In light of this fact, current conditions in the In light of this fact, current conditions in the U.S. have led the Fed to act in many U.S. have led the Fed to act in many different ways.different ways.

Financial CrisisFinancial Crisis

2007: Domestic Financial Crisis with 2007: Domestic Financial Crisis with International ImplicationsInternational Implications

Triggered by Liquidity ShortfallTriggered by Liquidity Shortfall

Sub –Prime Mortgages illustrated the nature Sub –Prime Mortgages illustrated the nature of banking, prompting the demise of some of banking, prompting the demise of some financial institutions and the bailouts of financial institutions and the bailouts of many moremany more

Worst Financial Crisis since the Great Worst Financial Crisis since the Great DepressionDepression

What Did the Fed Do?What Did the Fed Do?

As previously discussed, the role of Federal As previously discussed, the role of Federal Reserve is quite clearReserve is quite clear Promote employmentPromote employment Maintain healthy levels of inflationMaintain healthy levels of inflation

As the crisis emerged, the Fed acted in As the crisis emerged, the Fed acted in accordance with traditional monetary policy, accordance with traditional monetary policy, ultimately reducing short-term interest rates ultimately reducing short-term interest rates to nearly zeroto nearly zero

Purchase of US Purchase of US SecuritiesSecurities

The Fed purchased 1.75 Trillion Dollars The Fed purchased 1.75 Trillion Dollars worth of Treasury Securities and US-backed worth of Treasury Securities and US-backed mortgage securities in 2008 and 2009, mortgage securities in 2008 and 2009, lowering long term interest rateslowering long term interest rates

Bernanke’s view of the Great Depression: Bernanke’s view of the Great Depression: Money SupplyMoney Supply

Injection of liquidity helped pave the road Injection of liquidity helped pave the road to recoveryto recovery

Quantitative EasingQuantitative Easing

Purchase of Securities designed to increase Purchase of Securities designed to increase money supply and accomplish:money supply and accomplish: Reduce the cost of borrowingReduce the cost of borrowing Inflate asset pricesInflate asset prices Increase lendingIncrease lending

As a whole, Quantitative Easing is a less As a whole, Quantitative Easing is a less widely known tool of monetary policy, and it’s widely known tool of monetary policy, and it’s theory and practice is widely debatedtheory and practice is widely debated

Latest InstallmentLatest Installment

On November 5On November 5thth, The Fed announced the , The Fed announced the purchase of an additional 600 billion dollars purchase of an additional 600 billion dollars worth of long term securities, again worth of long term securities, again designed to reinvigorate the marketdesigned to reinvigorate the market

Reason and Rationale: While recovery is Reason and Rationale: While recovery is taking place, employment continues to be taking place, employment continues to be high and inflation is dangerously lowhigh and inflation is dangerously low

Possible Outcomes?Possible Outcomes? Only time will be the tellOnly time will be the tell

ConclusionConclusion

Monetary Theory and Practice is critical in Monetary Theory and Practice is critical in an understanding of Money and Bankingan understanding of Money and Banking

International Central Banks differ in design International Central Banks differ in design and practiceand practice

While economists continue to debate While economists continue to debate particular policy, there is no denying the particular policy, there is no denying the crucial role the Fed has played in the midst crucial role the Fed has played in the midst of our current economic crisisof our current economic crisis