A Look Inside Two Central Banks: The European Central Bank and the Federal Reserve

By Pollard, Patricia S. | Review - Federal Reserve Bank of St. Louis, January/February 2003 | Go to article overview
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A Look Inside Two Central Banks: The European Central Bank and the Federal Reserve


Pollard, Patricia S., Review - Federal Reserve Bank of St. Louis


Central banks have existed since the Swedish Riksbank began operation in 1668. The Federal Reserve, which was created in 1913, is thus a relative newcomer in the history of central banking: At the time of its creation, however, only 20 other central banks existed. The number of central banks rose rapidly in the post-World War II period primarily as a result of decolonization. This number expanded again in the early 1990s as the collapse of the Soviet Union led to the establishment of central banks by the former Soviet republics. By 1997 there were 172 central banks.1 In 1998 the coterie of central banks expanded by one, when the European Central Bank (ECB) became the newest member.

Central banking has changed greatly since its early history, when the primary function of a central bank was to act as the government's banker. Broz (1998) argues that financing military endeavors was the main reason for the establishment of the early central banks, pointing out that all "central banks in existence before 1850 were chartered in the context of war."2

By the time the Federal Reserve was established, the role of the central bank had evolved to focus primarily on providing stability in banking and financial systems. At this point, no mention had been made of monetary policy. The Federal Open Market Committee (FOMC), the policymaking group of the Federal Reserve, was not created until 1933.3

Today the primary function of a central bank is, in fact, monetary policy Moreover, it is widely accepted that a central bank needs to be able to operate independently within the government to best achieve its monetary policy goals. The statutes governing the ECB reflect these shifts and establish monetary policy as the primary function of the ECB, with many other tasks being delegated to the national central banks. The 1993 Maastricht Treaty amendments to the Treaty Establishing the European Community required that not only the ECB, but also the national central banks, be independent. In the 10 years since the Maastricht Treaty was signed, increasing attention has focused on counterbalancing central bank independence with accountability and transparency.

This article examines modern central banking with a focus on the world's two most prominent central banks-the Federal Reserve System and the European Central Bank.4 First, it examines the structure and appointment process of the key policymakers at the central banks. Next, it highlights the tasks of the central banks, focusing on the monetary policy process. The goals and tools of monetary policy as well as the decisionmaking process and how they differ in each system are discussed. Finally, the article examines accountability and transparency in the Federal Reserve and the ECB.

STRUCTURE OF THE ECB AND THE FEDERAL RESERVE

On June 1, 1998, the Executive Board of the ECB held its first meeting at its headquarters in Frankfurt, Germany Six months later the ECB assumed responsibility for monetary policy in the euro area, bringing to fruition a plan for monetary union first outlined nearly two decades earlier.5

The euro area is unique among common-- currency areas. Twelve sovereign nations have not only adopted a common currency, the euro, but have also created a supranational organization, the ECB; this institution, along with input from the head of each member country's national central bank, sets monetary policy for the euro area.

Ninety years ago, the Federal Reserve Act created a central bank for the United States consisting of 12 regional (District) Federal Reserve Banks (Figure 1) and a seven-member Federal Reserve Board in Washington, D.C.6 In 1935 the Federal Reserve Board was renamed the Board of Governors of the Federal Reserve System.

The European System of Central Banks consists of 15 national central banks (Figure 2) and a six-- member Executive Board in Frankfurt, Germany. The 15 central banks correspond to the 15 member countries of the European Union.

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