European Central Bank Dark History And Power PdfBy Adimar P. In and pdf 14.05.2021 at 11:59 7 min read
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- Get Ready for the Future of Money
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- How the U.S. and EU Central Banks View the Future of CBDCs
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Get Ready for the Future of Money
Michael D. Bordo is a contributing author. To receive email when a new Economic Commentary is posted, subscribe. More specifically, a central bank uses its tools of monetary policy—open market operations, discount window lending, changes in reserve requirements—to affect short-term interest rates and the monetary base currency held by the public plus bank reserves and to achieve important policy goals. There are three key goals of modern monetary policy.
The first and most important is price stability or stability in the value of money. Today this means maintaining a sustained low rate of inflation. The second goal is a stable real economy, often interpreted as high employment and high and sustainable economic growth. Another way to put it is to say that monetary policy is expected to smooth the business cycle and offset shocks to the economy.
The third goal is financial stability. This encompasses an efficient and smoothly running payments system and the prevention of financial crises. The story of central banking goes back at least to the seventeenth century, to the founding of the first institution recognized as a central bank, the Swedish Riksbank.
Established in as a joint stock bank, it was chartered to lend the government funds and to act as a clearing house for commerce. A few decades later , the most famous central bank of the era, the Bank of England, was founded also as a joint stock company to purchase government debt. Other central banks were set up later in Europe for similar purposes, though some were established to deal with monetary disarray.
For example, the Banque de France was established by Napoleon in to stabilize the currency after the hyperinflation of paper money during the French Revolution, as well as to aid in government finance. Early central banks issued private notes which served as currency, and they often had a monopoly over such note issue.
Because they held the deposits of other banks, they came to serve as banks for bankers, facilitating transactions between banks or providing other banking services. They became the repository for most banks in the banking system because of their large reserves and extensive networks of correspondent banks.
These factors allowed them to become the lender of last resort in the face of a financial crisis. In other words, they became willing to provide emergency cash to their correspondents in times of financial distress. The Federal Reserve System belongs to a later wave of central banks, which emerged at the turn of the twentieth century. These banks were created primarily to consolidate the various instruments that people were using for currency and to provide financial stability. Many also were created to manage the gold standard, to which most countries adhered.
The gold standard, which prevailed until , meant that each country defined its currency in terms of a fixed weight of gold. Central banks held large gold reserves to ensure that their notes could be converted into gold, as was required by their charters. When their reserves declined because of a balance of payments deficit or adverse domestic circumstances, they would raise their discount rates the interest rates at which they would lend money to the other banks.
Doing so would raise interest rates more generally, which in turn attracted foreign investment, thereby bringing more gold into the country. That is, the amount of money banks could supply was constrained by the value of the gold they held in reserve, and this in turn determined the prevailing price level.
And because the price level was tied to a known commodity whose long-run value was determined by market forces, expectations about the future price level were tied to it as well. In a sense, early central banks were strongly committed to price stability. They did not worry too much about one of the modern goals of central banking—the stability of the real economy—because they were constrained by their obligation to adhere to the gold standard.
Central banks of this era also learned to act as lenders of last resort in times of financial stress—when events like bad harvests, defaults by railroads, or wars precipitated a scramble for liquidity in which depositors ran to their banks and tried to convert their deposits into cash.
At the time, the Bank and other European central banks would often protect their own gold reserves first, turning away their correspondents in need. Doing so precipitated major panics in , , , and , and led to severe criticism of the Bank. The bank learned its lesson well. No financial crises occurred in England for nearly years after The U.
It had two central banks in the early nineteenth century, the Bank of the United States — and a second Bank of the United States — Both were set up on the model of the Bank of England, but unlike the British, Americans bore a deep-seated distrust of any concentration of financial power in general, and of central banks in particular, so that in each case, the charters were not renewed.
There followed an year period characterized by considerable financial instability. Between and the onset of the Civil War—a period known as the Free Banking Era—states allowed virtual free entry into banking with minimal regulation. Throughout the period, banks failed frequently, and several banking panics occurred. The payments system was notoriously inefficient, with thousands of dissimilar-looking state bank notes and counterfeits in circulation.
In response, the government created the national banking system during the Civil War. While the system improved the efficiency of the payments system by providing a uniform currency based on national bank notes, it still provided no lender of last resort, and the era was rife with severe banking panics.
It led to the creation of the Federal Reserve in , which was given the mandate of providing a uniform and elastic currency that is, one which would accommodate the seasonal, cyclical, and secular movements in the economy and to serve as a lender of last resort.
This changed after World War I, when they began to be concerned about employment, real activity, and the price level. The shift reflected a change in the political economy of many countries—suffrage was expanding, labor movements were rising, and restrictions on migration were being set. In the s, the Fed began focusing on both external stability which meant keeping an eye on gold reserves, because the U. But as long as the gold standard prevailed, external goals dominated.
The doctrine argued that the quantity of money needed in the economy would naturally be supplied so long as Reserve Banks lent funds only when banks presented eligible self-liquidating commercial paper for collateral. One corollary of the real bills doctrine was that the Fed should not permit bank lending to finance stock market speculation, which explains why it followed a tight policy in to offset the Wall Street boom.
The policy led to the beginning of recession in August and the crash in October. Then, in the face of a series of banking panics between and , the Fed failed to act as a lender of last resort.
As a result, the money supply collapsed, and massive deflation and depression followed. The Fed erred because the real bills doctrine led it to interpret the prevailing low short-term nominal interest rates as a sign of monetary ease, and they believed no banks needed funds because very few member banks came to the discount window.
In addition, the Fed was made subservient to the Treasury. The Fed regained its independence from the Treasury in , whereupon it began following a deliberate countercyclical policy under the directorship of William McChesney Martin.
During the s this policy was quite successful in ameliorating several recessions and in maintaining low inflation. At the time, the United States and the other advanced countries were part of the Bretton Woods System, under which the U. The link to gold may have carried over some of the credibility of a nominal anchor and helped to keep inflation low. The picture changed dramatically in the s when the Fed began following a more activist stabilization policy.
In this decade it shifted its priorities from low inflation toward high employment. Possible reasons include the adoption of Keynesian ideas and the belief in the Phillips curve trade-off between inflation and unemployment. The consequence of the shift in policy was the buildup of inflationary pressures from the late s until the end of the s.
The causes of the Great Inflation are still being debated, but the era is renowned as one of the low points in Fed history. The restraining influence of the nominal anchor disappeared, and for the next two decades, inflation expectations took off. The Volcker shock led to a sharp recession, but it was successful in breaking the back of high inflation expectations. In the following decades, inflation declined significantly and has stayed low ever since. Since the early s the Fed has followed a policy of implicit inflation targeting, using the federal funds rate as its policy instrument.
A key force in the history of central banking has been central bank independence. The original central banks were private and independent. They depended on the government to maintain their charters but were otherwise free to choose their own tools and policies. Their goals were constrained by gold convertibility.
In the twentieth century, most of these central banks were nationalized and completely lost their independence. Their policies were dictated by the fiscal authorities. The Fed regained its independence after , but its independence is not absolute. It must report to Congress, which ultimately has the power to change the Federal Reserve Act. Other central banks had to wait until the s to regain their independence.
An increasingly important role for central banks is financial stability. The evolution of this responsibility has been similar across the advanced countries. But financial systems became unstable between the world wars, as widespread banking crises plagued the early s and the s.
The experience of the Fed was the worst. The response to banking crises in Europe at the time was generally to bail out the troubled banks with public funds.
This approach was later adopted by the United States with the Reconstruction Finance Corporation, but on a limited scale. After the Depression, every country established a financial safety net, comprising deposit insurance and heavy regulation that included interest rate ceilings and firewalls between financial and commercial institutions.
As a result, there were no banking crises from the late s until the mids anywhere in the advanced world. This changed dramatically in the s. The Great Inflation undermined interest rate ceilings and inspired financial innovations designed to circumvent the ceilings and other restrictions.
These innovations led to deregulation and increased competition. Banking instability reemerged in the United States and abroad, with such examples of large-scale financial disturbances as the failures of Franklin National in and Continental Illinois in and the savings and loan crisis in the s.
The reaction to these disturbances was to bail out banks considered too big to fail, a reaction which likely increased the possibility of moral hazard. Many of these issues were resolved by the Depository Institutions Deregulation and Monetary Control Act of and the Basel I Accords, which emphasized the holding of bank capital as a way to encourage prudent behavior.
Another problem that has reemerged in modern times is that of asset booms and busts. Stock market and housing booms are often associated with the business cycle boom phase, and busts often trigger economic downturns. Orthodox central bank policy is to not defuse booms before they turn to busts for fear of triggering a recession but to react after the bust occurs and to supply ample liquidity to protect the payments and banking systems. This was the policy followed by Alan Greenspan after the stock market crash of It was also the policy followed later in the incipient financial crises of the s and s.
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Michael D. Bordo is a contributing author. To receive email when a new Economic Commentary is posted, subscribe. More specifically, a central bank uses its tools of monetary policy—open market operations, discount window lending, changes in reserve requirements—to affect short-term interest rates and the monetary base currency held by the public plus bank reserves and to achieve important policy goals. There are three key goals of modern monetary policy. The first and most important is price stability or stability in the value of money. Today this means maintaining a sustained low rate of inflation.
Taylor Eds. Summers Eds. Shultz Ed. Bergsten and Russell Green Eds. Peterson Institute for International Economics: Washington, , pp.
Directive (MiFID), which came into force in and was implemented in , set uniform pre-trade pools in Europe. Section 2 addresses the historical events – regulatory changes and (pdf). EU catalogue No.
How the U.S. and EU Central Banks View the Future of CBDCs
In Europe, a ruling by the German Constitutional Court that the European Central Bank ECB failed to adequately justify a program of asset purchases it began in is convulsing the political and financial scene. Some suggest it could lead to the unraveling of the euro. It may be difficult at first glance to understand why. Yes, the purchases were huge—more than 2 trillion euros of government debt. But they were made years ago.
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Imagine a digital currency that is as easy to share as an Instagram story, or an e-payments platform as ubiquitous as smartphones. Would bank accounts become obsolete? Would monetary policy matter? These futuristic questions have become more salient as the number of digital coins and tokens grows. When these experimental constructs move from the sandbox to the high street, the ramifications—good and bad—will be profound.
The European Union EU is a political and economic union of 27 member states that are located primarily in Europe. The EU has developed an internal single market through a standardised system of laws that apply in all member states in those matters, and only those matters, where members have agreed to act as one. EU policies aim to ensure the free movement of people, goods, services and capital within the internal market;  enact legislation in justice and home affairs; and maintain common policies on trade ,  agriculture ,  fisheries and regional development.