Thursday, February 07, 2008

A couple of questions...

Well, as discussed before with our tutor , making an argument for a 50bps rate cut by the BoE; news came out today of only a 25bps cut (see attached Wall Street Journal article). The ECB, however, decided to leave rates unchanged, citing above-target inflation rate.

My question would be:
1. How did the ECB determine that a 2% inflation target is the appropriate level? What factors are considered in such determination?
2. The article mentions that the ECB’s mandate is to control inflation, is that its sole mandate? What about growth stimulus? It seems so one-sided.

Question #1. Politics. Or more broadly societal pressures as to what levels are acceptable. In the book In Defense of "Globalization" Jagdish Bhagwati states how different societies expect and demand inflation and growth within certain boundaries. He noted even the lower segments of the economy in India strongly oppose anything beyond a very low inflation rates. While structuralist point out that in Latin America double digit inflation rates are common without much complaining. Even now Venezuela has hit 20% annual rate at times.

From the 16th chapter page473 of the book International Finance by Keith Pilbeam states:
"Finally, the French and German governments have held differing views on the extent to which the ECB will be able to operate an independent monetary policy; the Germans preferring complete independence with the sole objective of maintaining price stability, while the French prefer a politically accountable ECB with wider objectives such as higher employment and economic growth."

The whole chapter 16 answers your question. Basically the Germans got the upper hand as the German Central Bank had the most influence on decisions.

Question #2. As far as I have read, yes sole mandate. Yes one-sided but it would be hard to meet two policy objectives with one tool. As (page 78):
"The idea that a country generally requires as many instruments as it has targets was elaborated by the Nobel Prize-winning Dutch economist Jan Tinbergen (1952), and it is popularly known as Tinbergen's instruments-targets rule."

Anyway, I am sure you will enjoy the class (if you have not taken it yet).

One thing we should notice is that capital is not perfectly mobile even with all the talk about Globalization. Otherwise the BP (IS-LM-BP) curve is horizontal and we would not see such fluctuations in rates across countries. But lastly we would want to see what the real rates or better yet the expected rates of return are across countries.

(I feel claustrophobic...)

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Tuesday, February 05, 2008

The Grand Conspiracy|Federal Reserve and the Banking Cartel

As always the theories of the Federal Reserve and some Banking Cartel controlling the universe comes up in a forum. So let me see if I can come up with some information on these conspiracies...
First we should look and see what the Federal Reserve Act actually states and not what people state what it is suppose to say.

First about a completely autonomous organization that is not accountable to anyone, I would direct them to some of their responsibilities: SECTION 2B—Appearances Before and Reports to the Congress.

Secondly if it is "owned" by any cartel or banking trust then all proceeds would revert to "owners" after all expenses and capital requirements are met. Dividends and Surplus Fund of Reserve Banks explains how the distribution happens.
After all necessary expenses of a Federal reserve bank have been paid or provided for, the stockholders of the bank shall be entitled to receive an annual dividend of 6 percent on paid-in capital stock.

(B) The entitlement to dividends under subparagraph (A) shall be cumulative.

(2) That portion of net earnings of each Federal reserve bank which remains after dividend claims under subparagraph (1)(A) have been fully met shall be deposited in the surplus fund of the bank.
And this "profit" can and does get diverted to the Treasury. So much for them "owning" all proceeds from the bank. It goes on...
Should a Federal reserve bank be dissolved or go into liquidation, any surplus remaining, after the payment of all debts, dividend requirements as hereinbefore provided, and the par value of the stock, shall be paid to and become the property of the United States and shall be similarly applied.
Did I read that right all remaining after being dissolved will revert to the US Government?

This does bring up some issues of who are the "stockholders" that get first cut of retained earnings at a fixed rate. Instead of the sections individually, I want to use the following web page for the some more analysis: The Federal Reserve Act as amended.
SECTION 9--State Banks as Members

1. Applications for Membership by State Banks
Any bank incorporated by special law of any State, or organized under the general laws of any State or of the United States, including Morris Plan banks and other incorporated banking institutions engaged in similar business, desiring to become a member of the Federal Reserve System, may make application to the Board of Governors of the Federal Reserve System, under such rules and regulations as it may prescribe, for the right to subscribe to the stock of the Federal reserve bank organized within the district in which the applying bank is located. Such application shall be for the same amount of stock that the applying bank would be required to subscribe to as a national bank. For the purposes of membership of any such bank the terms "capital" and "capital stock" shall include the amount of outstanding capital notes and debentures legally issued by the applying bank and purchased by the Reconstruction Finance Corporation. The Board of Governors of the Federal Reserve System, subject to the provisions of this Act and to such conditions as it may prescribe pursuant thereto, may permit the applying bank to become a stockholder of such Federal reserve bank.
So simply banks that want to become a member of the Federal Reserve System become stockholders. Sounds good and is there any requirement of them to join?
5. Payment of Subscription
Whenever the Board of Governors of the Federal Reserve System shall permit the applying bank to become a stockholder in the Federal reserve bank of the district its stock subscription shall be payable on call of the Board of Governors of the Federal Reserve System, and stock issued to it shall be subject to the provisions of this Act.
Sorry greedy bankers, nothing comes for free. So basically a cooperative where member banks assume some liability but receive a capped premium for their capital that is provided to the Federal reserve system.

Understanding the Fed link does a good job explaining what points I have already pointed out including:
Independent Within Government
The Fed has a unique public/private structure that operates independently within government but not independent of it. The Board of Governors off-site, appointed by the president of the United States and confirmed by the Senate, represents the public sector, or governmental side of the Fed. The Reserve Banks and the local citizens on their boards of directors represent the private sector. This structure provides accountability while avoiding centralized, governmental control of banking and monetary policy.

The Federal Reserve is fiscally independent because it receives no government appropriations. The Fed funds its activities with the interest earned from loans to banks and investments in government securities and from the revenue received from providing services to financial institutions. The Fed’s financial goal in providing services is to generate only enough revenue to cover costs. Any excess earnings—money made above the cost of operations—is turned over to the U.S. Treasury.

Who Owns the Fed?
Banks that hold stock in the Fed are called member banks. All nationally chartered banks hold stock in the Federal Reserve. State-chartered banks may choose to be members, upon meeting certain standards. However, holding Fed stock is not like owning publicly traded stock. Fed stock cannot be sold or traded. Member banks receive a fixed, 6 percent dividend annually on their stock, and they do not control the Fed as a result of owning this stock. They do, however, elect six of the nine members of Reserve Banks’ boards of directors.

So who owns the Fed? Although it is set up like a private corporation and member banks hold its stock, the Fed owes its existence to an act of Congress and has a mandate to serve the public. So the most accurate answer may be that the Fed is "owned" by the citizens of the United States.
I think I should now look at membership of the Board of Governors and the Board of Directors for each Federal Reserve Bank.
The Fed’s Structure

The seven-member Board of Governors is the main governing body of the Federal Reserve System. The Board is charged with overseeing the 12 District Reserve Banks and with helping implement national monetary policy. Governors off-site are appointed by the president of the United States, one on January 31 of every even-numbered year, for staggered 14-year terms. The chairman and vice chairman of the Board of Governors are also appointed by the president and confirmed by the Senate to serve a four-year term. The nominees of these posts are selected from the Board membership.

Each Federal Reserve Bank has a board of directors, whose members work closely with their Reserve Bank president to provide grassroots economic information and input on management and monetary policy decisions. These boards are drawn from the general public and the banking community and oversee the activities of the organization. They also appoint the presidents of the Reserve Banks, subject to the approval of the Board of Governors. Reserve Bank boards consist of nine members: six serving as representatives of nonbanking enterprises and the public (nonbankers) and three as representatives of banking. The Federal Reserve branch offices have five- or seven-member boards that provide vital information concerning regional economies.
But maybe I can find a better way of describing these arrangements.
The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. Created in 1913 by the enactment of the Federal Reserve Act, it is a quasi-public (part private, part government) banking system[1] composed of (1) the presidentially-appointed Board of Governors of the Federal Reserve System in Washington, D.C.; (2) the Federal Open Market Committee; (3) 12 regional Federal Reserve Banks located in major cities throughout the nation acting as fiscal agents for the U.S. Treasury, each with its own nine-member board of directors; (4) numerous private U.S. member banks, which subscribe to required amounts of non-transferable stock in their regional Federal Reserve Banks; and (5) various advisory councils.
Let me explore some more into the Board of Governors from an earlier link.
1. Appointment and Qualification of Members
The Board of Governors of the Federal Reserve System (hereinafter referred to as the "Board") shall be composed of seven members, to be appointed by the President, by and with the advice and consent of the Senate, after the date of enactment of the Banking Act of 1935, for terms of fourteen years except as hereinafter provided...
In selecting the members of the Board, not more than one of whom shall be selected from any one Federal Reserve district, the President shall have due regard to a fair representation of the financial, agricultural, industrial, and commercial interests, and geographical divisions of the country. The members of the Board shall devote their entire time to the business of the Board...
2. Members Ineligible to Serve Member Banks; Term of Office; Chairman and Vice Chairman
The members of the Board shall be ineligible during the time they are in office and for two years thereafter to hold any office, position, or employment in any member bank, except that this restriction shall not apply to a member who has served the full term for which he was appointed.
4. Principal Offices; Expenses; Deposit of Funds; Members Not to Be Officers or Stockholders of Banks
No member of the Board of Governors of the Federal Reserve System shall be an officer or director of any bank, banking institution, trust company, or Federal Reserve bank or hold stock in any bank, banking institution, or trust company; and before entering upon his duties as a member of the Board of Governors of the Federal Reserve System he shall certify under oath that he has complied with this requirement, and such certification shall be filed with the secretary of the Board.
Just wanted to point out the restrictions on the Governors. I wonder how they handle Mutual Funds or other indirect ownership in banks? Maybe another day...

Overview of the Federal Reserve System:HTML

Federal Reserve System: Purposes and Functions-PDF

Grassroots: Federal Reserve Bank of 2003 Atlanta-Annual Report-PDF

Understanding the Fed

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Ben and King|Moral Hazards or Effects of Globalization

a fellow student in
class...from class has provided the following views of monetary policies from both sides of the pond. The first is from the Economist that talks about Ben Bernanke and his recent decisions: Aggressive activism
The second article is from the Wall Street Journal: Bank of England Chief Changes Tack in Crisis

a fellow student in
then posed the following questions:
1. Do you think now that the Federal Reserve activist response is the most
appropriate (and briefly why)? – No. I absolutely agree with Wayne Robert’s
points regarding issues of moral hazard raised by the Fed’s actions.

or 2. Do you think the Bank of England cautious response is appropriate (and
briefly why)? – I do think that the BoE response was more appropriate, although
it would be difficult to compare the two as the BoE action was Ex-Post, whereas
the Fed’s actions were Ex-ante.

In the purest form, Policy makers should be concerned only with the long-run
rate of growth of the economy, rather than react to immediate shocks. However,
as history have shown, they are also quick to intervene in the face of
extraordinary events, such as LTCM (Fed-arranged bailout).

It appears that a delicate balancing act of maintaining the safety & soundness
of the financial system is also part of the Fed’s “job description”.

Kind Regards,
-a fellow student in
Let me first say that I am more of a structuralist. As such what we expect to work in one economy may be completely different in another economy. Now if the US and UK are identical then it would be reasonable that they would have nearly identical monetary policies, but they are not (IMO). Thus I expect that we would treat things not equal to the degree of their differences.

I am not even sure if it is fair to compare both situations or to even conclude that one was ex-post and one was ex-ante. For that matter it seems both were ex-post, it was just different signals that triggered the response.

One thing that seems to be different is the aspects of how financial globalization has affected the collections of economies in the world. Bernanke discuses some of these issues at Globalization and Monetary Policy and some response from me at Articles of Interest.

I am not sure if Bernanke had any clues about the following coming but this seems to be a real serious problem that deserved the types of responses that Ben tried. January 2008 Non-Manufacturing ISM Report On Business® did state:
The January 2008 Non-Manufacturing ISM Report On Business® is being released early today due to a possible breach of information. This early release time is for today's Report only.
for all Divergent Thinkers out there (lol). And for the numbers:
Business Activity Index at 41.9%
New Orders Index at 43.5%
Employment Index at 43.9%
Anything below 50% is considered contraction in the market and it was noted that:
Business activity in the non-manufacturing sector contracted in January for the first time in 58 months, say the nation's purchasing and supply executives in the latest Non-Manufacturing ISM Report On Business®.

The report was issued today by Anthony Nieves, C.P.M., CFPM, chair of the Institute for Supply Management™ Non-Manufacturing Business Survey Committee; and senior vice president — supply management for Hilton Hotels Corporation. "The new NMI (Non-Manufacturing Index) at 44.6 percent indicates contraction within the non-manufacturing sector for January 2008. Non-manufacturing business activity contracted for the first time since March 2003," Nieves said. He added, "The New Orders Index contracted to 43.5 percent, the lowest since October 2001. The Employment Index contracted to 43.9 percent, the lowest since February 2002. (And for a good summary of the numbers: U.S. ISM services-sector index plunges in January.)
As far as a fellow student in
's two questions, I still feel that I do not have enough information to give a definitive answer as well as the fact that I do not believe I have the same quality or quantity of information that Ben and Mervyn have.

U.S. ISM services-sector index plunges in January

ISM Services Index Fell More Than Forecast in January (Update3)

Going back to a fellow student in
's comments:
It appears that a delicate balancing act of maintaining the safety & soundness of the financial system is also part of the Fed’s “job description”.
Unlike other sectors banking can easily cause contagions to spread through the economy and destroy it. So I would say yes, preventing runs on banks and maintaining the soundness of the financial systems (not equity markets) is a job of the Fed. Of course even if we are not sure how, equity markets tend to be a leading indicator of the overall health of an economy and as such it should be taken as another indicator in their analysis. Of course the ISM report has a larger bearing IMHO.