Evolution Of The Central Bank Essay, Research Paper

Final Paper

Evolution of the Central Bank

An important idea that the revolutionary United States originated is the separation of powers. That idea applies not only to a nation?s government but also her central banking system. Like the government itself, a central bank requires autonomy from the government while exercising influences on each other. The complementary effect leads to a successful national economy. In analyzing the history and development of the Bank of England, the Bank of Japan, and the United States Federal Reserve, one understands the necessary elements and their contributions to the evolution of central banks.

The oldest central bank is the Bank of England. Founded in 1694, the Bank of England?s structure reflects its age and history. By an Act of Parliament, the Bank of England opened with the Bank of England Stock which represented the beginning of the Funded National Debt. Nineteen bankers comprised the Bank?s first staff. Its initial objectives were to: issue notes for deposits, act as the banker to the Government, and manage government securities (Bank of England). As the forerunner for central banks, the Bank of England?s original tasks and structure were fundamental. However, due to various historical events, the Bank of England has undergone a number of reforms since its establishment.

Prior to this year (1998), the Bank Act of 1946 gave the English government statutory power over the Bank. The Bank of England Act 1998, effective June 1, 1998, altered the Constitution and the Court of Directors? responsibilities. Before this reform, the Bank could only make recommendations on monetary policies (Mishcin 405). The chancellor of the Exchequer (equivalent to the U. S. Secretary of the Treasury) decided on raising or lowering interest rates. The 1998 Act weakened the monarchy?s control over the central bank and formed the current structure and obligations.

The Bank of England consists of the Court of Directors which in turn contains two subdivisions, the Monetary Policy Committee and the Committee of the Court. The Crown appoints the Court of Directors? Governor, two Deputy Governors, and sixteen Non-Executive Governors (Bank of England). The executives serve five-year renewable terms while the Directors serve three year renewable terms (Bank of England). The Chancellor of the Exchequer designates the Chairman of the Committee of the Court and the four economists of the Monetary policy Committee (Bank of England). The sixteen Non-Executive Directors form the Committee of the Court. The Monetary Policy Committee, a more separate entity than the Committee of the Court, comprises the Court?s Governor, the two Deputy Governors, two Bank Executive Directors, and the four experts assigned by the Chancellor (Bank of England).

Each sector of the Court maintains separate responsibilities which, to an extent, balances influence and authority. The Court of Directors meets at least once a month to manage non-monetary policy affairs. Such affairs include determining the Bank?s objectives and strategies, guaranteeing positive effects from Bank functions, and efficiently allocating the Bank?s resources (Bank of England). The Committee reviews the Bank?s performance, regulates its financial management, and determines the Governor?s and Deputy Governor?s salaries (Bank of England). The Committee also checks the performance of the Monetary Policy Committee (Bank of England). The Non-Executive Chairman leads the Committee and the Court in case of the Governor?s absence (Bank of England). This recent restructuring of the Bank of England signifies a trend towards liberalism. Other banks, such as the Bank of Japan, also follow this trend originated by the United States? banking system.

A highly influential central bank in the Asian market is the Bank of Japan, or Nippon Ginko. During the Meiji Restoration, the Japanese established their Bank to avoid severe economic struggles in 1882 (Bank of Japan). The Bank of Japan was not originally independent of the government, as ultimate power belonged to the Ministry of Finance. However, as with the Bank of England, political and economic changes have translated into banking changes. Presently, the Bank of Japan enjoys a substantial independent practice.

The Bank of Japan Law, promulgated on June 11, 1997 and effective April 1, 1998, describes the Banks? organization and powers. Leadership of the Bank resides upon the Policy Board and its nine members. The Cabinet appoints the Governor, two Deputy Governors, and sixteen Deliberative Members (The Bank of Japan Law). The Governor and Deputies hold five-year renewable terms who (The Bank of Japan Law). The entire Board elects one of them to the Chairman position (The Bank of Japan Law). The Cabinet also appoints three or less Executive Auditors for four-year terms (The Bank of Japan Law). The Board recommends six or less Executive Directors, four-year terms, and a few Advisors, two-year terms, whom the Minister of Finance ultimately determines (The Bank of Japan Law). The Governor then declares the Board?s staff. This new structure reveals progression from the older, inefficient one.

As with other central banks, the Bank of Japan maintains the function of the nation?s economy. The Policy Board?s missions and activities include: the issuance and management of bank notes, the implementation of monetary policies, the providing of settlement services and ensuring the stability of the financial system, the operations of treasury and government securities, involvement in international affairs, and the compilation economic data and research (Bank of Japan). The Board ultimately establishes the increase or discount of interest rates. As the “Bank of banks,” the Bank of Japan regulates activities among various financial institutions as well as government securities. Collectively, the Policy Board?s activities attempt to prevent economic decline and, thus, promote economic growth.

The United States Congress created the Federal Reserve System in 1913, after the English and Japanese bank establishments. Elements of the Federal Reserve harbor the original American ideas of freedom and power separation. The Fed?s structure trail-blazed other current central banks? traits in regulating the national economy semi-independently of the government. The U.S. Congress was the first to recognize the importance of denying total government control over the central bank?s operations.

The Federal Reserve is unique in its make-up and its segmented responsibilities. The Fed divides into four major components: the Board of Governors, the Federal Advisory Committee, the Federal Open Market Committee, and twelve Federal Reserve Banks. The U.S. President selects, and the Senate confirms, seven members of the Board of Governors. Each of the twelve Federal Reserve Banks have nine directors, three of whom the Board of Governors appoints and six of whom the thousands of commercial banks. The Federal Reserve Banks? directors select twelve bankers to the Federal Advisory. The Board of Governors, the president of the New York Federal Reserve Bank, and the presidents of four other Federal Reserve Bank constitute the Federal Open Market Committee. The individuals above collectively allocate their knowledge and experience to current economic issues.

The advantages of the Federal Reserve System affect monetary policy. The key tools of monetary policy are reserve requirements, open market operations, interest rates. The Federal Reserve banks establish an interest rate which the Board of Governors reviews and determines. The Board also sets, within limits, the reserve requirement ratio. The Federal Open Market Committee directs the FEDS open market operations. The twelve Banks also monitor the commercial banks? day-to-day operations. Such activities include check clearing, currency issuance and withdrawals, and analyzing local busines. The U.S. Federal Reserve System maintains a more diverse structure than the older Banks of England or Japan to accomplish similar goals for national economic stability.

The relationship between each nation?s government and her central bank holds infinite significance. The Bank of England, the earliest form, was a model for central banks to follow. However, later establishments, particularly the U.S. Federal Reserve System, corrected the errors of the English system and implemented new ideas for a progressive banking structure. Through experience and periods of economic decline, the current organizations of England?s and Japan?s central banks follow the path paved by the U.S. After understanding each bank?s history and organization, one can analyze the changes made and why the U.S. system proves its superiority.

Since the United States declared independence from England, a common American theme has been the separation of powers. Thus, the Federal Reserve System formulates a quasi-public structure:

Each governor is appointed by the president of the United States and confirmed by the Senate. To limit the president?s control over the Fed and insulate the Fed from other political pressures, the governors serve one nonrenewable 14-year term, with one governor?s term expiring every January. The governors (many are professional economists) are required to come from different Federal Reserve districts to prevent the interests of one region of the country from being over-represented (Mishcin 395).

The terms above illustrate the dual effects of government influence on the Fed and vice-versa. While no one segment maintains any more power than another, each segment an focus on its responsibilities. The form applies ideas from government structure to the central bank to ensure a prosperous national economy.

The separation of powers results in multiple effects. The executive and legislative branches determine some of the officers of the Federal Reserve. However, the length of the Board of Governors? terms do not coincide with the President?s. Therefore, the political influence of each presidential office does not necessarily affect the duration of a governor?s term. While the President in office indirectly suggests economic policies, the Fed is essentially independent of the government.

The Fed also operates internally on a sort of checks and balances system. Each subdivision of the Fed cooperates in determining and implementing the facets of monetary policy issues. As described beforehand in the Federal Reserve System, the sectors of the Fed agree on any changes needed within the policy tools. Thus, the unique structure of the U.S. central banking system provides a model for other nations? banks. The U.S. system proves to be the most efficient one as current changes in the English and Japanese banks adapt.

The Bank of England recognized its faults and the U.S. Fed?s advantages in 1946 as Parliament instigated the division of the Bank from the government. Time and experience exposed the need for further improvements in the Bank of England?s structure:

The Bank of England Act 1998, which came into force on 1 June 1998, changed the constitution and duties of the Court of Directors from that set out in the previous Act of 1946, strengthening the Bank?s governance and accountability, as well as formalising the bank?s responsibility for the conduct of monetary policy (Bank of England).

The new act imitates the facets of the U.S. Fed by allowing the Bank to operate autonomously.

Like the U.S. system, the Bank of England associates itself with the government while acting exclusively. Concerning monetary policy, the Bank now controls interest rate changes, but Parliament does hold substantial influence:

The legislation will provide that if, in extreme circumstances, the national interest demands it, the Government will have the power to give instructions to the Bank on interest rates for a limited period (Bank of England).

The stipulation mirrors the checks and balances idea originated by the U.S. While the government determines some members of the Court, the Bank is a self-entity. The government can also dictate any interest rate changes subject to limitation. Thus, the Bank of England Act 1998 recognizes the need for the Bank?s independence and the government?s overall influence on the Bank.

The necessary changes noted by the Bank of England relate to those of the Bank of Japan. The new Bank of Japan Law mirrors the organizational process described by the U.S. and new English systems. Article 3 of the Law reads, “The Bank of Japan?s autonomy regarding currency and monetary control shall be respected” (The Bank of Japan Law). The Japanese government establishes the Bank as a separate body. The Bank possesses ultimate control over its duties. However, while the Bank is independent, the government and bank retain the necessary cooperation between the two.

As with the U.S. and English bank structures, the Bank of Japan realizes that neither the government nor the Bank may exercise too much power. Article 4 of the Law notes this point:

In recognition of the fact that currency and monetary control is a component of overall economic policy, the Bank of Japan shall always maintain close contact with the government and exchange views sufficiently, so that its currency and monetary control on the basic stance of the government?s economic policy shall be mutually harmonious (The Bank of Japan Law).

To ensure this “harmony” between the two bodies, following articles allow the government to express its views in Board meetings. The Minister of Finance and the Minister of Economic Planning Agency may make suggestions or postpone the Board?s vote on a particular issue. Again, the government and the central bank complement each other on economic subjects.

The recent changes in the English and Japanese central banks illustrate the need for each banks? autonomy. The founders of U.S. independence originated the idea of separation powers with constraints. A central bank is similar to any government; to achieve success as a whole, no one body can indulge in total power. The U.S. Federal Reserve Chairman, Alan Greenspan, concurs with this idea regarding the current Asian economic crisis:

My sense is that one consequence of this Asian crisis is an increasing awareness in the region that market capitalism, as practiced in the West especially in the United States, is the superior model; that is, it provides greater promise of producing rising standards of living and continuous growth. . . . As a consequence, many of the leaders of these countries and their economic advisors are endeavoring to move their economies much more rapidly toward the type of economic system that we have in the United States (Greenspan 2).

Greenspan was correct in the above testimony made on March 3, 1998. National economic awareness identifies the advantages of the U.S. Federal Reserve System and the prosperity those advantages bode. As shown above, The Bank of Japan Law and The Bank of England Act 1998 have conformed to the U.S. system to apply such advantages.

The various changes in each central bank illustrate the evolution of central banks and the differences in the law structures of the countries discussed. England initially established its central bank subjective to its government. Once the United States became its own nation, her founding fathers stressed the importance of separate powers and applied that importance to the Federal Reserve System. As time reveals, the Fed?s structure proved to be the successful one for economic stability. After critical economic periods, England and Japan recently installed structures mirroring the Fed?s to promote their economic stability. Thus, central banks have evolved from the original Bank of England to the U.S. Federal Reserve System and the current Bank?s of England and Japan.