Chapter 16
The Structure of Central Banks:
The Federal Reserve and the European Central Bank
Conceptual and Analytical Problems
1. What are the Federal Reserve’s goals and who established them? How are Fed
influential Fed official. (LO1)
Answer: Congress mandates the Federal Reserve to “maintain long run growth of
maximum employment, stable prices, and moderate long-term interest rates.”
The Fed releases large amounts of information in order to maintain accountability.
inflation objective (based on the price index of personal consumption
expenditures) allows the public to assess the Fed’s performance in meeting its
congressionally-mandated goals.
Finally, as leader of the FOMC, the Fed Chair influences policy by controlling (i)
the staff of the Board of Governors that produces the material distributed to
Committee chooses.
2. Go to the Federal Reserve Board’s website and locate the FOMC’s most recent
statement. What did the committee members say at their last meeting regarding
and sustainable economic growth? (LO2)
Answer: In a statement released February 1, 2017, the FOMC stated: “In view of
realized and expected labor market conditions and inflation, the Committee
further strengthening in labor market conditions and a return to 2 percent
inflation.”
3. Some people have argued that the high inflation of the late 1970s was a
consequence of the fact that Federal Reserve Board Chairman Arthur Burns did
what President Richard Nixon wanted him to do. What policy do you think
Nixon might have wanted? (LO2)
Answer: Because politicians are elected for relatively short terms, they often favor
short-term political objectives.
4. How might the ECB’s pursuit of price stability as its primary objective restrict its
response to the sovereign debt crisis in the euro area? (LO3)
Answer: A short-term solution to the sovereign debt crisis would be for the ECB
to buy all the bonds of the highly indebted countries that they are unable to sell to
euro area and could lead to higher inflation and a loss of ECB credibility.
5. Evaluate the following statement: “The Treaty of Maastricht helped solve the time
consistency problem in monetary policy but not fiscal policy.” (LO3)
Answer: The time consistency problem for monetary policy was addressed by
establishing a highly independent central bank. Independence resulted from
of rising debts. Perhaps more important, fiscal well-being was undermined by
unforeseen risks, such as the need in several countries to recapitalize their
banking systems.
6. How did the response to the financial crisis of 2007-2009 alter the appointment
process of presidents of the regional Federal Reserve banks? (LO1)
Answer: The bailouts of financial institutions during the crisis fueled a public
perception that the regional reserve banks are too sympathetic to the private
change was modest compared to earlier proposals, one of which would have made
the bank presidents direct appointees of the U.S. President (subject to approval by
7. What are the goals of the ECB? How are its officials held accountable for meeting
them? (LO3)
Answer: The primary goal of the ECB is to maintain price stability, which the
Like the Federal Reserve, the ECB is held accountable through releases of
information, including its target interest rate, the explanatory statements that
8. Why did the sovereign debt problem of Greece – which accounts for less than 2
(LO3)
Answer: Banks throughout the euro area held Greek government debt. When its
value fell, bank capital at these banks declined, making banks throughout the
region riskier than before. More important, concerns about sovereign default and
prolonged and deep economic recession that damaged other assets on the banks’
balance sheets (including, for example, real estate-related loans). In some
countries – such as Greece and Spain – the recessions resulted in Great
Depression-level unemployment.
9. Go to the ECB’s web site and locate the most recent introductory statement made
it justified? Is there any reference to financial stability measures? (LO3)
Answer:
In the introductory statement at the press conference following the Governing
Council’s meeting, Mario Draghi, President of the ECB stated, “we decided to
towards a sustained adjustment in the path of inflation, we stand ready to increase
our asset purchase programme in terms of size and/or duration,” regarding
financial stability.
10. Do you think the FOMC has an easier or a harder time agreeing on monetary
policy than the Governing Council of the ECB? Why? (LO3)
Answer: The FOMC and ECB have similar numerical inflation objectives.
However, the presence of national biases may make agreement among members
FOMC members) is likely to have an easier time coming to a decision than a
group of 25 (the current number of ECB Governing Council members).
11. Why did the “no-bailout” clause of the Maastricht Treaty come under stress
during the financial crisis of 2007-2009? (LO3)
Answer: Large fiscal deficits in some euro-area countries threatened the ability of
those governments to borrow. A disruption to sovereign borrowing in one country
due to their strong inter-linkages.
12. Do you think the current procedures for appointing members to the Board of
Governors are consistent with the principles of good central bank design?
Explain your answer. (LO1)
Answer: The length of the terms and the fact they are staggered reduces the
opportunity for political influence on the selection of the governors and so these
procedures are consistent with central bank independence. However, the
independence in a democratic society.
13. *Currently, all the national central banks in the Eurosystem are involved with the
day-to-day implementation of monetary policy. What do you think the advantage
would be of centralizing the conduct of these day-to-day interactions with
think of? (LO3)
Answer: The main advantage would be in terms of efficiency. Conducting these
interactions at 19 different national central banks is more cumbersome than
disadvantage would be the loss of local market knowledge, although this issue
should become less and less important over time.
14. If you were charged with re-drawing the boundaries of the Federal Reserve
districts, what criteria would you use to complete the task? (LO1)
Answer: Ideally, the districts should reflect a diverse range of economic interests.
15. Entering 2016, interest rates and inflation had been low for some time. The
FOMC added to its annual statement of longer-run goals that it would be
emphasized this “symmetry” of its price-stability goal? (LO2)
Answer: The symmetry of the inflation objective encourages expectations that—
whether inflation is persistently above or persistently below the 2% goal—the
FOMC will act over time to restore inflation to the goal. In the 1980s and 1990s,
stabilize inflation. The FOMC made the statement when both interest rates and
inflation had been persistently low and long-term inflation expectations were
16. Why do you think the statement released after each Federal Open Market
Committee meeting retains the same basic structure? (LO2)
Answer: Maintaining the same structure for the statement promotes transparency
and is thought to be a good communication strategy. The market knows what
of policy that the committee did not intend to give.