Federalizing a Central Bank: A Comparative Study of the Early Years of the FED and the ECB

Abstract

In its early years, the Federal Reserve System struggled with making regional considerations subordinate to supraregional considerations. The importance of regional shocks, the strong exposure of banks to their regional economies, and the governance and shareholding structure of the Fed made the United States prone to regional feedback loops that had the ability to undermine the par convertibility of currency across the United States. The authors argue that these issues were finally put to rest when the relationship between the Federal Reserve banks and the federal government was clarified during the 1933 Banking Holiday and as mechanisms for ensuring automatic par clearance across the 12 Federal Reserve districts were improved. By comparison, the Eurosystem at its inception was far better designed to avoid the pitfalls of making national borders relevant in the conduct of monetary policy. But the modification of risk-sharing arrangements over the past few years — first as a by-product of the extension of its collateral framework and the growing importance of liquidity provision through the European Central Bank's (ECB) emergency liquidity assistance and then with the public sector purchase program—threaten to make euro area consideration subordinated to the national considerations of member states. In the spirit of the Rooseveltian reforms of the 1930s, the authors suggest the ECB would benefit from a form of political if not fiscal underwriting of the credit risks of its policies.