The European Central Bank

As we noted earlier, the Fed is only one of a number of central banks around the world, and it’s much younger than Sweden’s Sveriges Rijksbank and Britain’s Bank of England. In general, other central banks operate in much the same way as the Fed. That’s especially true of the only other central bank that rivals the Fed in terms of importance to the world economy: the European Central Bank.

The European Central Bank, known as the ECB, was created in January 1999 when 11 European nations abandoned their national currencies, adopted the euro as their common currency, and placed their joint monetary policy in the ECB’s hands. (Six more countries have joined since 1999.) The ECB instantly became an extremely important institution: although no single European nation has an economy anywhere near as large as that of the United States, the combined economies of the eurozone, the group of countries that have adopted the euro as their currency, are roughly as big as the U.S. economy. As a result, the ECB and the Fed are the two giants of the monetary world.

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Who Gets the Interest on the Fed’s Assets?

As we’ve just learned, the Fed owns a lot of assets—Treasury bills—which it bought from commercial banks in exchange for the monetary base in the form of credits to banks’ reserve accounts. These assets pay interest. Yet the Fed’s liabilities consist mainly of the monetary base, liabilities on which the Fed doesn’t pay interest. So the Fed, in effect, is an institution that has the privilege of borrowing funds at a zero interest rate and lending them out at a positive interest rate. That sounds like a pretty profitable business. Who gets the profits?

You do—or rather, U.S. taxpayers do. The Fed keeps some of the interest it receives to finance its operations but turns most of it over to the U.S. Treasury. For example, in 2013 the Federal Reserve System received $79.5 billion in income—largely in interest on its holdings of Treasury bills, of which $77.7 billion was returned to the Treasury.

We can now finish the story of the impact of those forged $100 bills allegedly printed in North Korea. When a fake $100 bill enters circulation, it has the same economic effect as a real $100 bill printed by the U.S. government. That is, as long as nobody catches the forgery, the fake bill, for all practical purposes, serves as part of the monetary base. Meanwhile, the Fed decides on the size of the monetary base based on economic considerations—in particular, the Fed doesn’t let the monetary base get too large because that can cause inflation. So every fake $100 bill that enters circulation basically means that the Fed issues one less real $100 bill. When the Fed issues a $100 bill legally, however, it gets Treasury bills in return—and the interest on those bills helps pay for the U.S. government’s expenses. So a counterfeit $100 bill reduces the amount of Treasury bills the Fed can acquire and thereby reduces the interest payments going to the Fed and the U.S. Treasury. So taxpayers bear the real cost of counterfeiting.

Like the Fed, the ECB has a special status: it’s not a private institution, but it’s not exactly a government agency either. In fact, it can’t be a government agency because there is no pan-European government! Luckily for puzzled Americans, there are strong analogies between European central banking and the Federal Reserve System.

First of all, the ECB, which is located in the German city of Frankfurt, isn’t really the counterpart of the whole Federal Reserve System: it’s the equivalent of the Board of Governors in Washington. The European counterparts of the regional Federal Reserve Banks are Europe’s national central banks: the Bank of France, the Bank of Italy, and so on. Until 1999, each of these national banks was its country’s equivalent to the Fed. For example, the Bank of France controlled the French monetary base.

Today these national banks, like regional Feds, provide various financial services to local banks and businesses and conduct open-market operations, but the making of monetary policy has moved upstream to the ECB. Still, the various European national central banks aren’t small institutions: in total, they employ more than 50,000 people; in December 2012, the ECB employed only 1,638.

In the eurozone, each country chooses who runs its own national central bank. The ECB’s Executive Board is the counterpart of the Fed’s Board of Governors; its members are chosen by unanimous consent of the eurozone national governments. The counterpart of the Federal Open Market Committee is the ECB’s Governing Council. Just as the Fed’s Open Market Committee consists of the Board of Governors plus a rotating group of regional Fed presidents, the ECB’s Governing Council consists of the Executive Board plus the heads of the national central banks.

Like the Fed, the ECB is ultimately answerable to voters. Given the fragmentation of political forces across national boundaries, however, it appears to be even more insulated than the Fed from short-term political pressures.