Question

1. What are the main differences and similarities between the Federal Reserve system (Fed) and the European Central Bank system (ECB).

2. Discuss the case for and the case against Federal Reserve bank independence.

3. Explain two concepts of central bank independence. What about the Fed?

4. Why central bank independence is important?

Answer 1

1) Federal reserve system and European central bank are both central banks of respective jurisdiction where they regulate the monetary policies. The Federal reserve is the central banks of the United states and ECB is the central bank and monetary authority of the members of the Euro zone. The major difference between these two is that US federal reserve during times of economic volatility is very active in buying or selling treasury where ECB is more focused on providing financial support to its members as well as policy recommendation.

2) The case for the federal reserve independence is that the objective of central bank is to maintain price stability in the economy while the government want to boost the GDP growth for its political gain so government often pressurizes the central bank to cut interest rate to boost GDP even if in the long run it is going to hurt the economy so by giving it freedom the federal reserve can focus on its core objective of maintaining price stability. The case against its freedom is in a democracy the Federal reserve are not elected by people but by the congress and in turn congress is elected through voting so giving complete autonomy is not justifiable to an organization which is not elected by people.

3) There are two dimensions of independence of a central bank, political independence and economic independence. The political independence is the freedom to set its monetary policies without any intervention from the political system to maintain price stability in the long term. The economic independence is its ability to operate without any significant financial support from the central government. The federal reserve enjoys economic independence because of its strong earnings and political independence is also to at certain extent because there has not been major pressure to change its policy.

4) The central bank independence is important to achieve its objective. The central bank wants to create an environment of price stability where long-term sustainable economic growth can be achieved and inflation is not exceeding a certain level but the government focus is on GDP because of the election and public perception that if the GDP is not doing well that means the government is not doing well so central bank freedom to at certain extent is very important.