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Both the U.S. Federal Reserve (the Fed) and the European Central Bank seem to be geared toward a common goal, producing money. However, the tools that the specified institutions have chosen to reach their objectives are quite different. While the Fed relies on its dual policy, the European Central Bank focuses on maintaining inflation rates at a two-percent threshold.
The U.S. Federal Reserve (the Fed) and the European Central Bank have been recognized as some of the largest financial institutions in the world. Producing money to support state governments, organizations have a significant effect on the fiscal policies chosen by the respective states (Eitemann, Stonehill, & Moffett, 2013). Financing the state governments that are at the helm of the specified organizations can be viewed as part and parcel of their routine. In other words, the United States and the countries of the European Union owe their economic and financial wellbeing, as well as the creation of new job opportunities and the associated improvements in the state economy to the respective organizations. Even though the missions of the institutions are very similar, the approaches they choose to meet the set objectives are quite different.
The U.S. Federal Reserve and the European Central Bank
At first glance, both the U.S. Federal Reserve and the European Central Bank are aimed at the same goal—producing money. However, after closer scrutiny of the institutions, one must admit that the paths chosen by the organizations to attain the identified goals are very different.
The U.S. Federal Reserve deploys a dual policy as an essential means of meeting key objectives. Specifically, the organization offers reserve and clearing balances accounts for depository institutions, whereas for governmental agencies, the bank provides the services of a fiscal agent (Board of Governors of the Federal Reserve System, 2016a).
The European Bank, in its turn, focuses on reducing the rate of inflation to two percent (European Central Bank, 2016). Furthermore, it is the priority of the institution to maintain the levels of the financial development of the states, as well as their economic growth at a high rate. Consequently, it would be reasonable to assume that the creation of job prospects for the people living in the target countries, as well as a reduction in unemployment rates, should be listed among the top priorities of the organization. A closer look at the framework used by the European Central Bank will show that the organization follows an approach known as the produce-money-and-lend (PML) strategy (Eitemann et al., 2013). The name of the tool is self-explanatory; the organization produces financial assets and lends them to the corresponding financial institutions for an unlimited time period. Banks, in their turn, use the money provided by the European Central Bank to purchase bonds (Tsen, 2014).
The Fed, on the other hand, incorporates the produce-money-and-purchase (PMP) method in its financial endeavors. The framework implies that the financial assets created by the organization can be used to purchase bonds, as well as American treasuries. By applying the PMP approach, the Fed assumes the role of a regulator of the American banking system. In other words, it sets the standards that will later guide the related institutions and define the choice of strategies by American banks and associated organizations in the context of the American and global financial markets.
Seeing that the U.S. Federal Reserve has a direct impact on the institutions that depend on it, its chosen approach in the context of the American economy can be viewed as superior to the one that the European Central Bank applies to the EU domain. Indeed, a closer look at some of the recent changes in the economies of EU states such as Greece will show that the PML tool does not allow exerting enough influence to maintain economic growth rates consistent in the realm of specific states (Ehrmann, Osbat, Strasky, & Uuskula, 2014).
Priorities, Policies, and Their Effect on the Exchange Rate
As stressed above, the ECB uses the exchange policy as a tool to affect the exchange rate. It should be borne in mind, though, that the current approach toward impacting exchange rates with the help of monetary policy is likely to have a detrimental effect on the stability of prices for goods and services in the country (European Central Bank, 2007).
When considering the factors that contribute to the increase in the European Central Bank’s impact on exchange rates, one must bring up the fact that the latter has been volatile since the breakdown of the Bretton Woods System in 1973 (Tsen, 2014). Therefore, the Central Bank has been intervening in the relationships in the financial market to reduce the volatility of the exchange rates and maintain the rates of financial flow and economic growth at comparatively high levels (Eitemann et al., 2013).
The way in which the U.S. Federal Reserve affects exchange rates is slightly different. For the bank to have an effect on the subject matter, it needs to work in tandem with the U.S. Treasury (Board of Governors of the Federal Reserve System, 2016b). Together, they keep exchange rates high by making the job market stronger and creating employment opportunities for the U.S. population.
Board of Governors of the Federal Reserve System. (2016a). Federal Reserve’s key policies for the provision of financial services. Web.
Board of Governors of the Federal Reserve System. (2016b). How does the foreign exchange value of the dollar relate to Federal Reserve policy? Web.
Ehrmann, M., Osbat, C., Strasky, J., & Uuskula, L. (2014). The euro exchange rate during the European sovereign debt crisis – dancing to its own tune? Journal of International Money and Finance, 49, 319-339. Web.
Eitemann, D. K., Stonehill, A. I., & Moffett, M. (2013). Multinational business finance. Upper Saddle River, NJ: Pearson Education, Inc.
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European Central Bank. (2007). The exchange rate policy of the Euro. Web.
European Central Bank. (2016). Monetary policy. Web.
Tsen, W. H. (2014). Exchange rate and central bank intervention. Journal of Global Economics, 2(1), 1-4. Web.