Euro Challenge Orientation: Monetary Policy Basics Wednesday, January 27, 2010

1. Miami Branch Euro Challenge Orientation: Monetary Policy Basics Wednesday, January 27, 2010

2. Disclaimer: The views expressed are those of the presenter and do not necessarily reflect those of the Federal Reserve Bank of Atlanta or the Federal Reserve System.

3. History

4. History of the Fed • 1791 – 1811: First Bank of the United States • Nation’s first Central Bank • Helps unify country’s economy • Faced major opposition • 20 year charter not renewed • 1816 – 1836: Second Bank of the United States • Serves same functions as First Bank • Financed debt from War of 1812 • Bank President Nicholas Biddle and U.S. President Andrew Jackson at odds over bank • 20 year charter not renewed • Central banking was not revived for more than 75 years

5. History of the Fed • 1863: The National Banking Act was passed • Nationally-chartered banks • Bank notes backed by U.S. government securities • 1913: Federal Reserve System Established • Nation’s third central bank • Banking Panic of 1907 raises need for central bank • Created safer and more stable monetary and banking system • The Fed has a 20 year charter, however, McFadden Act of 1927 gave Fed permanence

6. History of the ECB • 1952: The European Coal & Steel Community • Founding members were Belgium, Germany, France, Italy, Luxembourg and the Netherlands Bank • To withdraw resources used for war to preserve peace • 1958: European Economic Community and European Atomic Energy Community (Euratom) • 1967: European Communities (now known as the European Union) • ECSC, EEC and Euratom merged • Joint decisions and policies for many industries

7. History of the ECB • 1988: European Council confirmed EMU • EC central bank governors formed a committee of monetary policy experts • Resulted in the Delors report that details a three step program to achieve EMU • 1992: Treaty on European Union • Established the European Union • Added chapter on monetary and economic policy • 1999: European Central Bank opened • Currency among initial 11 member banks was fixed • Single monetary policy • 2002: Introduction of Euro Currency and Coin

8. Structure and functions

9. Federal Reserve System Structure • The Board of Governors • 12 Federal Reserve Banks • 24 Branches European Central Bank Structure • Executive Board • 16 Eurosystem Banks (have adopted the euro) • 27 EU Member Central Banks

13. Federal Reserve Board of Governors • Seven members • Appointed by U.S. president and confirmed by the Senate • Staggered, 14-year terms • Ben Bernanke, Chairman European Central Bank Executive Board • Six members • Appointed by the Heads of State of member countries • 8 year term • Jean Claude Trichet, President

14. Federal Reserve Goal To promote economic growth, stable prices and maximum employment. Why? Multiple bank failures throughout history due to inflexible financial system & periods of high unemployment European Central Bank Goal To maintain price stability Why? Due to Germany’s hyperinflation in the 1920’s with the issuance of the 50 million Mark note

15. Federal Reserve Primary Functions • Conduct monetary policy • Supervise and regulate the banking system • Provide payment services European Central Bank Primary Functions • Conduct monetary policy • Conducting foreign exchange operations • Promote an efficient payment system • Hold and manage foreign reserves

16. Federal Reserve Monetary Policy FOMC • The Seven Governors have voting authority • Five Reserve Bank Presidents have voting authority (New York and four others on a rotating basis) • The Seven non-voting Presidents participate fully in FOMC Meetings • The FOMC meets eight times per year European Central Bank Monetary Policy Governing Council • Six members of the Executive Board • 16 Governors of National Central Banks • Meet twice a month, first meeting to conduct monetary policy, second to discuss ECB management

17. Conclusion Both central banks try to achieve broadly similar objectives even if their strategies are different.

18. Economic Indicators and statistics

19. Why do Central Banks use economic indicators? • Essential to making effective monetary policy • Both the U.S. dollar and Euro are fiat currencies • Value is not pegged to commodities, but rather to national wealth • If money supply is not proportionate to national wealth, then either inflation or deflation can result • M x V = P x Q • M = Supply of Money • V = Velocity of Money • P = Price levels • Q = Quantity of goods and services

20. How can a central bank affect the economy? Let’s try a little simulation… Remember: M x V = P x Q Which variable(s) are we adjusting? What is the impact?

21. Gross Domestic Product - GDP • What is GDP? • Measures the total value of goods and services produced within a country in a given period • Also measures a country’s total income • What is growth rate? • The percent increase or decrease of GDP from a previous measurement cycle • Why use GDP per capital for cross country comparison? • Allows you to measure apples to apples

22. What are the components of GDP? Exports Imports Inventories Fixed Investment Residential Nonresidential GDP Personal Consumption Expenditures (C) Investment (I) Government (G) Net Exports (NX) GDP =C+I+G+NX

23. Unemployment • What does unemployment measure? • Measures the percent of those in the labor force (excluding discouraged workers) that are unemployed • Are there different types of unemployment? • Cyclical – unemployment rises with a downturn in the economy and rises when the economy improves • Frictional – individuals who are transitioning, entering the workforce for the first time or re-entering, usually voluntary • Structural – a mismatch between skills and availability of workers and vacancies in the job market.

24. Inflation and Deflation • What is inflation? • A situation in which the economy’s overall price level is rising • What is deflation? • A situation in which the economy’s overall price level is decreasing • What are the measures of inflation/deflation? • Consumer Price Index • Producer Price Index • Personal Consumption Expenditures Price Index

25. Inflation The job of central banks is to keep inflation low by influencing the money supply. This is accomplished by through open markets operations, setting interest rates and bank reserve requirements.

26. Comparison of Economies *2008 estimates Ref: www.cia.gov www.tradingeconomics.com/economics/interest-rate.aspx

27. ECB Member Countries *2008 estimates Ref: www.cia.gov

28. QUESTIONS