The Primary Reasons for the Creation of Central Banks Especially in the U.S - Essay Example

1) What were the primary reasons for the creation of Central Banks especially in the U.S.? Who were the key players in the Federal Reserve Act? From very initial years of the development of US banking system, two major fears were in influence including the centralized authority and domination by moneyed interests. These fears were coupled with the determination to prevent the development of a financial system under the control of large institutions or political forces. The primary reason of creation of central banks was to reduce these two fears. Another reason to create central bank was to restrict the practice of small independent banks to open branches across the state boundaries. Actually, with the significant decentralization of the banking system of US, the problems increased especially during recession, when the multi-bank panics and frequent bank collapses happen. For example, between the closure of the Second Bank of the United States and in the late years of first decade of the twentieth century, total nine multi-bank panics happened. In consideration to the frequent collapses of small banks, the need of a structure of central bank with regional banks was identified. Eventually, after the panic of 1907, in 1913 a commission of inquiry was set up and the Federal Reserve Act was passed. In the absence of a central bank in the 19th century, the federal government used to act its own banker and the treasury could favor the specific geographic, economic and financial interests. Therefore, another aim of creating central banks was to finance and meet the centralized needs of the Treasury. The central bank of the United State, Fed was set up with an aim that it could operate independent of both the private financial business interests and duly constituted government authorities. The key players in shaping the Federal Reserve Act were Glass Steagall Act 1933 and Regulation Q. These two key players not only allowed the Federal Reserve Bank to reduce the riskiness of system but they also enhanced the authority of Federal Reserve Bank. 2) Discuss the importance of the regional fed banks in the structure of the fed and why the NY fed is so much more important than others. It was being assumed before the creation of regional fed banks that central banks are too large and it was against the democratic ideals of the USA for example, in 1832, USA president argued that Second Bank of US had given the power to few irresponsible people. Actually, the establishment of a central banking system has always been parallel with the fear of excessive control from the centre. Therefore, rather than setting up a single bank, the Federal Reserve Act established a system of twelve regional Federal Reserve Banks overseen by a Federal Reserve Board. In this way, the regional fed banks reduced the fear of excessive control from the centre. The regional Federal Reserve Banks also provided an extensive view of economic activity in all regions of the state. This system did not only eliminate the problem of private ownership of large banks by the foreign investors but it also reduced the geographical concentration of the central bank. The aim of creating this structure of fed was to ensure the sufficient supply of credit in each region and when regional fed banks were established in 1913, they actually played an important role as lenders of last resorts in their districts, as fiscal agents of government, banks of rediscount and reserve for member banks. Moreover, the regional structure also assisted the FOMC in setting up a more effective monetary policy. The power of New York Fed Bank was grown because New York was the largest money and capital market in the United States and the New York Fed Bank became the primary agent for the other reserve banks in the buying of securities. In addition, being the largest capital market, government securities were placed in the on the New York capital market and the prices of securities were largely influenced by the policies of the New York Reserve Bank. 3) Greater transparency by the Fed in its actions and of its meetings via timely releases of meeting statements, minutes, transcripts and frequent speeches by FOMC members are a good thing or bad? Discuss one good outcome and one bad outcome as a result of this greater transparency. Federal Reserve Bank has achieved a significant level of independence however; the bank is expected to maintain a significant level of transparency and accountability. To fulfill these requirements, Fed has been timely releasing the minutes of its meetings. There are both the negative and positive outcomes which Fed may face. Actually independence of Fed usually leads the financial markets to take benefits of this information to damage the reputation of central bankers and Fed’s policies. Moreover, through their actions, the financial markets can also make it difficult for Fed to fulfill its mandates. In consideration to the behavior of the financial markets, Fed feels itself more accountable to financial markets as compared to the political system. Therefore, to keep maximum level of transparency, after each meeting Fed issues the minutes of the meetings or chairman’s review. This point is actually a favorable point when it comes to evaluate the transparency and accountability of Fed Reserve Bank. On the other hand, a high level of transparency may also result negative consequences such as negative thoughts and assumptions of public or political leaders. For example, at its December 1998 meeting, it was decided that the prospective developments related to the increase or decrease in the targeted Federal Fund rates would be announced. Although the aim of this announcement was to keep a transparency and to convey to public the assessment of balance of risks and policy learning however, the impact of these statements really created a tension in the market. From then onwards, Fed decided to only express the committee view after every meeting through standard statements. Although Fed can face bad outcomes as a result of negative assumptions made by public or financial markets over its released statements, however, the strategy of Fed to release the chairman’s view and the way its expresses its meeting conclusions, can actually help Fed to avoid negative outcomes or circumstances. Read More