The Fed, the Eurosystem, and the Bank of Japan: More similarities or differences?

Francesco Paolo Mongelli, Dieter Gerdesmeier , Barbara Roffia 07 February 2009

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Central banks have always been important players in financial markets. They set key interest rates, which are at the origination of the monetary transmission process, they are monopoly suppliers of base money, and they perform a number of other tasks and functions. Central banks can better perform their mission and fulfil their goals when they are understood by the public and other policy makers. One of the youngest members of the central banking community is the Eurosystem (a supranational central banking system). The purpose of this column is to highlight some of its organisational features through a systematic comparison with other central banks.

The Eurosystem comprises the European Central Bank (ECB) and the national central banks (NCBs) of those EU Member States that have adopted the euro (and, therefore, make up the euro area). With the launch of the euro on 1 January 1999, the Eurosystem acquired responsibility for setting the single monetary policy in the euro area. The Eurosystem is led by the Governing Council of the ECB, which is in charge of formulating monetary policy. We compare the Eurosystem to the US Federal Reserve System (the “Fed”, which was established in 1914), and the Bank of Japan (“BoJ”, which was established in 1882).

Organisational framework and institutional features

The governing bodies of the Eurosystem are the Governing Council and the Executive Board. The latter consists of the President, the Vice President, and four board members. Its main task is to implement the decisions of the Governing Council, which currently consists of the Executive Board members plus the 16 governors of the euro area NCBs (see Figure 1).

Figure 1. Organisational framework of the Eurosystem

Note: NCBs refers to the National Central Banks of the 16 euro area countries from January 2009. Source: Gerdesmeier, Mongelli and Roffia (2007).

The institutional arrangements of the Eurosystem in some ways resemble those of the Fed (see Figure 2) –, both are federal central bank systems. The Fed became more centralised with the Banking Act of 1935. For its part, the ECB has in principle a role similar to that of the Fed’s Board of Governors, while the 16 NCBs of the Eurosystem play a role similar to the 12 regional Federal Reserve Banks in the US. In a similar fashion, the President of the ECB chairs the Governing Council meetings in much the same way as the Chairman of the Fed’s Board of Governors chairs meetings of the Federal Open Market Committee (FOMC) that is responsible for formulating monetary policy in the US.

While the structures of the Eurosystem and the Fed share many similarities, there are also some key differences. One concerns voting rights. Currently, all NCB governors have an equal vote in all policy decisions taken by the Eurosystem Governing Council. Participation in FOMC voting, in contrast, is more restricted – all seven members of the Board of Governors of the Federal Reserve System have a permanent voting right, as does the President of the New York Fed, whereas the Presidents of the Chicago and Cleveland branches alternate annually, and the other nine reserve bank presidents share only four votes on a rotating basis, although they do all attend the FOMC meetings and participate in the discussions even when they cannot vote. The voting system of the Governing Council will change when more countries adopt the euro.

Figure 2. Organisational framework of the Federal Reserve System

Notes: FRBs are the regional Federal Reserve Banks of the 12 districts. The solid arrow in the implementation stage denotes the fact that the FRBNY is entrusted with a conduct of open market operations. The dashed arrow in the implementation stage denotes the fact that the Board of Directors of each Fed bank sets the discount rate (subject to the approval of the Board of Governors). Source: Pollard (2003).

The Bank of Japan’s decision-making body is its Poicy Board (see Figure 3). The Board comprises the Governor, two Deputy Governors, and six appointed members. Each of these nine members is appointed by the Cabinet for five years, and his or her appointment must be approved by the Diet. The board members elect the Chairman of the Policy Board among themselves. Since September 2006, the Governor of the Bank has also been appointed Chairman of the Policy Board. The Policy Board takes its decisions by a majority vote. The BoJ operates more as a head office than a federal system of central banks and is in charge of 32 domestic local branches (LBs) and 12 local offices (LOs).

Figure 3. Organisational framework of the Bank of Japan

Source: Bank of Japan (2003).

The monetary policy framework

The table below provides an overview of the institutional and policy-making frameworks of the Eurosystem, the US Federal Reserve System, and the Bank of Japan. There are some differences in the terms and length of the appointments of policy makers, and all three central banks emphasise the importance of independence.

Table 1. Monetary policy frameworks

  Eurosystem Federal Reserve System Bank of Japan
Established/ Made independent 1998 1914 1882/1998
Monetary policy decision-making body Governing Council, comprising 22 members: the ECB Executive Board (6 members) and the Governors of the 16 NCBs of the Eurosystem Federal Open Market Committee (FOMC),12 members: 7 Board Governors, President of the New York Fed, and 4 of the 11 other reserve banks FedPresidents on rotating basis; 19 participants Policy Board, 9 members
Appointment of policy makers President and Governing Councilmembers appointed for 8 years by nationalgovernments; ratified by European Parliament Governors (14 year terms)/Chairman(4 year term) appointed by the President and approved by the Congress; Bank Presidents selected by Bank directors (largely local banking/ business community) Board members appointed for 5 years by the cabinet;parliamentary ratification required
Independence from political influence Yes. Enshrined in the Maastricht Treaty Yes. Fed is a “creature of the Congress” and must report regularly, but enjoys substantial independence by long-standing tradition Yes. Established in the 1998 BoJ law, but (at times) not well respected by the political establishment
Monetary policy objective(s)/ Mandate Price stability is the primary objective as set in the Maastricht Treaty. The ECB has quantified this as medium-term inflation goal of “below but close to 2%” Multiple objectives: to promote maximum employment, pricestability, and moderate long-term interest rates. Price stability not defined, but widely viewed as 1-2% comfort zone (skewed toward upper portion) for core PCE inflation Multiple objectives: price stability and the stability of the financial system. Price stability objective is set in qualitative terms in the 1998 law and policy board has quantified this as a range of 0% to 2% inflation in the medium term
Monetary policy strategy Two pillar strategy. First pillar focuses on shorter-term economic and pricedevelopments (“economic pillar”); Second pillar focuses on longer-term inflation outlook based on monetary analysis Focus on economic forecasts; rates adjusted to optimise expected outcomes and minimise risks of deviating from those outcomes (factoring in costs of those deviations). Preference forgradualism unless risks dictate more aggressive action

Two perspectives strategy, the first focusing on short-term inflation developments and the second on economic and inflation developments as well as financial stability in a longer-termperspective

Decision-making style Consensual, with the President assuming the role of moderator; dissents are rare Consensual (less so under Bernanke than Greenspan), with Chairman clearly first among equals. Dissents are infrequent, multiple dissents are very rare By majority vote; dissents are frequent (55% of decisions since the BoJ law was enacted were taken with at least one dissenter); Governor is generally opinion leader
Role of monetaryaggregates and asset prices Both play a significant role Neither plays a significant role independent of their effects on growth and inflation Both play a significant role
Accountability and transparency a. Immediate pressconference after Council meetings with introductory statement and Q&A (2:30 pm local time)  a. Immediate announcement following the FOMC, with voting record (2:15 pm local time) a. Immediate announcement after monetary policy meetings (around 12 noon local time) with voting record, followed by Governor's press conference (3:30 pm local time)
  b. Annual Report to EU institutions andpresentations to theEuropean Parliament b. Meeting minutes three weeks later b. Minutes (generally a month later, three days after next monetary policy meeting)
  c. Monthly Bulletin published c. Full transcripts of meetings five years later c. Monthly Report of the Policy Board 34-40 days after meetings
  d. Speeches d. Frequent speeches by FOMC participants d. Speeches
    e. Semi-annual monetary policy report to Congress; other hearings e. Semi-annual report to the Diet
Sources: Websites and other publications of BoJ, ECB and the Fed. See also Gerdesmeier, Mongelli, and Roffia (2007) and references therein.

 The economic and financial environment in which the central banks operate

A factor that is contributing to reducing the differences between the Eurosystem, the Fed, and the BoJ are the declining “internal” differentials in their economic and financial environment. A few examples will suffice. From 1980 to 2008, inflation dispersion in the US remained within a considerably narrow range, whereas in the euro area it trended downward reaching levels comparable to those in the US just prior to the launch of the euro (ECB 2008). Inflation differentials in Japan have remained at a very low level since the 1980s. Differentials in economic growth have all sharply declined over the last 10-15 years. All things considered, the Fed and the BoJ still operate in a more harmonious economic and financial environment.

Other tasks of the Eurosystem, the Fed, and the BoJ

In addition to the monetary policy function, all three central banks perform diverse other functions and tasks (see table below) most of which are relatively similar, although some vary on the grounds of other factors (some of which historical) that are not addressed here (for more information in this regard, see Gerdesmeier, Lichtenberger and Mongelli, 2005).

Table 2. Other tasks

  Eurosystem1 Federal Reserve System Bank of Japan
Issue banknotes Yes Yes Yes
Conduct foreign exchange operations Yes Yes Yes
Hold and manage official reserves NCBs Yes Yes
Act as the fiscal agent for the government Yes Yes Yes
Promote stability and financial system Yes Yes Yes
Supervise banks Some NCBs Yes On a contractual basis
Promote the smooth operation of the payments system Yes Yes Yes
Collect statistical information Yes Yes Yes
Participate in meetings of international monetary institutions Yes Yes Yes

Sources: BoJ (2003a), ECB (2004), Gerdesmeier, Mongelli and Roffia (2007) and Pollard (2003).

1 The acronym NCBs here refers to the national central banks of the Eurosystem.

Final remarks

The status and the mandate of the three central banks differ somewhat. This reflects different historical conditions, as well as national characteristics, at the time of their creation. However, changes to central banking practices (especially trends towards greater independence and transparency) and changes to the general economic and financial environment over the past two decades have clearly reduced the differences among these monetary authorities.

In particular, regarding the monetary policy strategy, the ECB has a two-pillar strategy, the FED has multiple indicators, and the BoJ has multiple indicators and focuses on money and financial assets. In terms of objectives, the ECB has a price stability objective, the Fed has multiple objectives, and the BoJ has a range for inflation developments.
In this column, we compared the institutional structures and monetary policy frameworks of the three most important central banks. In future work, we will investigate the frequency and amplitude of the setting of the respective key policy interest rates in a descriptive analysis and from the perspective of a Taylor-rule framework. This may allow us to judge how much the actual monetary policies differ among the three central banks.

Note: The views expressed are those of the authors and do not necessarily reflect those of the European Central Bank.

References

Bank of Japan (2003), “About the Bank of Japan.” Annual Review, 78-118.

Blinder, Alan S. (2004), The Quiet Revolution: Central Banking Goes Modern, New Haven: Yale University Press.

European Central Bank (2004), The Monetary Policy of the ECB, 2nd edition, European Central Bank, Frankfurt am Main.

European Central Bank (2008), 10th Anniversary of the ECB, Special Edition of the ECB Monthly Bulletin, June 2008.

Gerdesmeier, Dieter, Jung-Duk Lichtenberger and Francesco P. Mongelli (2005), “A Brief Comparison of the Eurosystem, the US Federal Reserve System, and the Bank of Japan.” In Elements of the Euro Area: Integrating Financial Markets, edited by Jesper Berg, Mauro Grande and Francesco Paolo Mongelli, pp: 33-52. Aldershot: Global Financial Series, Ashgate.

Gerdesmeier, Dieter, Barbara Roffia and Francesco P. Mongelli (2007), “The Eurosystem, the US Federal Reserve, and the Bank of Japan: Similarities and Differences.” Journal of Money, Credit and Banking, 39:7, 1785-1819.

Pollard, Patricia S. (2003), “A Look inside Two Central Banks: The European Central Bank and the Federal Reserve.” Review of the Federal Reserve Bank of St. Louis, January/February, 11-30. 

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Topics:  Monetary policy

Tags:  Central Banks, monetary policy frameworks