Rewriting and revision processes

¶ … ECB can be successful at emulating the strategic model set forth by the German Bundesbank. The discussion will focus on the fact that the ECB is facing different problems as it is still in the developmental phases. The investigation will seek to determine whether the tools of the Bundesbank can provide support for the ECB in achieving economic stability in the European Monetary Union.

Research about this particular topic is important because the European Union is expected to expand in the years to come. In addition, many members of the European Union have opted to have a single currency. This means that economic stability is even more essential in ensure that the European Monetary System is economically efficient.

The methodology for this research will encompass several forms. Firstly, the research will contain background information about the ECB and the Bundesbank. In addition, the research will contain a literature review to give the reader and the researcher an understanding of prior research. Data for the literature review will be obtained from secondary sources such as periodicals.

The research will also contain information taken from the internet. The internet sources will be limited to official websites for the ECB and the Bank of England. It will also contain information gathered from internet databases.

Interviews will also be conducted to determine various points-of-view about the ECB. These interviews will be conducted with members of the ECB along with the public. The researcher is seeking to discover if the public perception of the banks performance is an accurate depiction of the actual performance of the bank.

Once all of this data has been gathered, it will be used to compare the banks to one another. This will enable the researcher to determine if the ECB can be successful at implementing the standards that have been established by the Bundesbank. It will also provide answers as to whether the structures of the banks are identical.

Overview of literature review

The Goals of central banks are broad ranging but tend to focus on price stability. The current role of the Central Banks is still developing with many arguing that current tasks are inadequate in most banks, despite the model of the Bundesbank. Both Bob Mundell and Milton Freidman agree that when it comes to managing monetary policy the overall record of central banks is very poor (Dowd, 2001).

Central banks have been in existence for centuries, but the role and operation has differed greatly. Central banking texts often look to the beginning of central banking at the end of the seventeenth century with the creation of the Bank of England. The evidence of Britain's superior economic, financial and military being credited, in part at least, to the creation and operation of the central bank (Weingast, 1992, North and Weingast, 1989).

The Bank of England has been essential to the economic stability of the UK. According to a book entitled The Bank of England, 1891-1944 Vol. 2 that since the foundation of the bank in 1694 it operated as a joint-stock company. Sayers (1996) also asserts that "Between 1890 and 1946 the formal constitutional arrangements of the Bank were modified only once, by a Supplemental Charter granted in 1896, though its duties, in relation for example to the issue of notes and payments in gold, were affected by twelve Acts of Parliament between 1913 and 1939." (pp 593) Indeed, the Bank of England was one of the first stable central banks in the world.

The Bundesbank is also a central bank that has received a great deal of attention. The Bundesbank has served as a benchmark for central banks for many years. The Bundesbank is important in understanding how central banks function. Frazer (1994) explains that the Bundesbank was once a dominant force in the reestablishment of the German economy. Engelen (2002) argues that the once dominant Bundesbank is now secondary to the European Central Bank.

The European Central Bank is now the primary bank for the European Union. (Dyson and Featherstone 1999) argue that the ECB was created for providing the EMU with monetary policy. Dunn (2001) explains that there have been many problems associated with the management of the institution. The author argues that,

"The years 1999 and 2000 have provided a difficult beginning for the European Monetary Union (EMU) and for its managing institution, the European Central Bank (ECB). The euro, which was almost universally expected to be a strong currency, has depreciated sharply and is now the source of widespread negative commentary. Citizens of Denmark voted against joining the monetary union by a considerably larger majority than had been anticipated, and there is now virtually no chance that a referendum for entering the EMU could pass in the United Kingdom or Sweden. The management of the ECB has been widely criticized, with its president being the frequent target of unkind press comments. (Dunn 2001, pp 14)

Discussion and Conclusion

As you can see the information found thus far asserts that the Bundesbank is a benchmark for many central banks. The research also suggests that the ECB has had trouble in the implementation of the banking system. The proposed research will delve into these subjects in more detail to determine is the ECB has the ability to duplicate the success of the Bundesbank.

1. Chapter

Case study research: The Deutsche Bundesbank and the European Central Bank

Will the European Central Bank be as successful as its successor the Bundesbank? -- The formation and Role of the German Bundesbank

To identify the association and evaluate the potential of the ECB to perform at the same level of professionalism and achievement as the Bundesbank, we need to garner a better understanding of the Bundesbank. This can be accomplished with a detailed explanation of the Bundesbank banking system; including, the development that lead to the success that the Bundesbank experienced in the last few decades.

The German Bundesbank came to prominence following the Second World War. The steady development of the bank was in response to the political and economic climate. Ultimately, Bundesbank became the benchmark for many other European Banks. The Bundesbank has played an important function in the creation and development of the ECB.

According to a book entitled "Fifty Years of the Deutsche Mark: Central Bank and the Currency in Germany since 1948. Article 3 of the Bundesbank asserts, "Bundesbank regulates the amount of money in circulation and of credit supplied to the economy, and arranges for the execution of payment transactions. Its goal is to safeguard the currency, meaning to safeguard the value of money (Baltensperger 1999, 219)."

The Bundesbank was very successful in its endeavours to maintain economic stability. In fact, the Bundesbank has been historically regarded as one of the finest banking systems in the world. The founding of the Deutsche Bundesbank also called the Bank deutscher Lander came at a pivotal time in European history.

Today, Germany may be viewed as being fashioned by post World War II allies and the influence that they had on the economic and political climate of the country. In particular, the Soviet Union and the United States both sought to influence the region according to their own interests and vision for the future (de Hann, 2003). This political scenario aided the development of the Bundesbank (de Hann, 2003). Germany was in a strategic position, and during the cold war, these former allies believed that Germany was essential to winning the cold war. This belief was based on the premise that Germany was a conduit to mainland Europe.

In 1949, the German constitution was created, and was influenced by the United States (Uwe, 1994). The Grundgesetz (the basic law), created two authorities, the Bund which is comparable to the federal authorities in the United States and the Land, which is akin to the state authorities (Uwe, 1994). This had the effect of reviving the federalism tradition that had existed in Germany in the past. (Uwe, 1994).

The structure of the Bundesbank is a replica of the Grundgesetz and the Bund, as stated in the constitution (Uwe, 1994). It is worth noting that in Article 88 the framers foresaw the need to create a central bank in the future. Nevertheless, details concerning how the central bank should be formed were not pinpointed which allowed for future legislation (Uwe, 1994). Prior to the creation of the Bundesbank, the Bank deutscher Lander (BdL -- Bank of German States) dictated monetary policy. In addition, this bank had the task of co-ordinating the central banks of the regional states known as the Lander (Uwe, 1994).

The Bank deutscher Lander was an independent bank; as such, it was not controlled by the government. It was organised into regional offices, which were based in the Lander. However, the banks policies were not independent at this stage, as they required a level of approval by the Allied Banking Commission that governed the western zone (the area that the Soviet Union did not have control). The bank had the power of veto (Uwe, 1994).

Even though this veto existed it was never used, this may be due to the manner in which Wilhelm Vocke, the president of the Bank deutscher Lander, managed the difficult political situation of the bank (Uwe, 1994). He was able to negotiate and co-ordinate policies with the Commission, creating a stable banking environment and one that was able to negotiate through the political difficulties, which were external but influenced the bank.

By 1950, the legislation for the creation of the central bank had begun. The legislation was formed under Chancellor Konrad Adenauer. During the creation of the legislation differences emerged between the parties involved regarding what the correct leadership should be between the central bank and the political authorities. It was argued by Fritz Schaffer, the finance minister, that the veto, which had been present with the Allied Banking Commission should be transferred to the Federal Government of Germany, and that the Bundestag should oversee the bank (de Hann, 2003).

Adenauer also argued that the central bank policy should be controlled by the government (Uwe, 1994). Vocke believed that the bank should be independent of government control (Uwe, 1994). Voke was not alone, Ludwig Erhard, a government minister, also known as the "father of Germany's economic miracle" also supported the idea of an independent bank (de Hann, 2003) .These differences in opinion led to a situation in which there was a difficult relationship between Adenauer, the Bank deutscher Lander and later the Bundesbank, which was its successor (Uwe, 1994). These differences in belief persisted, and it was 1957 before the passing of the Bundesbank Act (Uwe, 1994).The basis of the Bundesbank was the former Bank deutscher Lander. The Bundesbank policies were founded upon the lessons and patterns that had been seen in the past.

An area of success for Bundesbank has been that of price stability and the controlling of inflation. In the decades prior to Bundesbank, there was an inflationary condition. The 1920's saw great difficulties because of very high inflation (Hetzel, 2002). In the years following, the defeat of Germany in the Second World War there was also pressure on the economy and the demand for a stable economy, which also entered into the political culture of the time (de Hann, 2003). This culture was inherited and adopted by the Bundesbank and was retained throughout the history of the Bundesbank as a key value (de Hann, 2003). The period prior to the formation of the Allied Banking Commission and later the Bundesbank, must be understood to appreciate the culture. It is also important to understand how price stability was ingrained in culture as well as policy.

During the Weimar Republic era, there was hyperinflation and the currency collapsed. If we compare the currency to the U.S. dollar, which was stable at this stage, prior in to the First World War the value was 4.2 Reichsmarks to the dollar, meaning to buy a dollar it would cost 4.2 Reichsmarks. By 1919, the Reichsmarks had halved in value meaning that a dollar would cast twice the amount (Hetzel, 2002). The downwards spiral was eventually halted with the Reichsmarks reforms that took place in 1923 after the peak of hyperinflation and a record level of deflation was reached (Hetzel, 2002). A new currency was introduced, backed with the guarantee from a non-governmental body. This laid the foundation for a period of economic stability, which lasted from 1924 to 1928 (Hetzel, 2002

The result of the Weimar Republic was displayed in its ultimate failure and the rise of the dictatorship, the Nazi Party and eventually World War II. During the war, the German mark had retained its value. However, this was not the result of a strong stable economy, although there was an economic 'golden age' prior to the war, it was the force of the Nazi leaders and the way they used their power to reinforce this policy (Hetzel, 2002). After Germany lost the war many forms of exchange moved away from a market system to a barter system. Goods such as chocolate and tobacco products that were obtained from occupying forces had a greater value on the market, until the introduction of the Deutschmark to the economy on the 20th of June 1948 (Hetzel, 2002).

There were several stages involving the implementation of the Deutschmark. During the first stage, individuals were allowed to make an exchange of forty old marks for Deutschmarks. Thereafter, in August of 1948 twenty old marks could be exchanged for twenty new Deutschmarks, this was undertaken as the rate of ten to ten, ten old marks making one new Deutschmark for those with bank accounts. October 1948 also saw the receipt of 65 pfennig on the marks they held (de Hann, 2003, Hetzel, 2002).

This move re-established the German economy, which many critics credit with the jump-starting of the contemporary Germany economy (Hetzel, 2002). This introduction would later serve as model used during the 1990 reunification between East and West Germany. The main purpose of all these strategies was the creation of price stability and confidence in the economy.

The implication is that where there is economic failure there can also be political collapse. The need for political stability means that there has to be economic stability. When the Bank deutscher Lander was established, the purpose of the Bank was viewed as currency protection and to achieve this, the Bank believed they needed to be independent from the government (Wood, 1993).

This approach appears to be supported by evidence from other countries. For example, during this time, there was a 1.600% increase in prices in Britain, where the central bank was not independent, 48% increases were seen in the U.S. And 300% in Switzerland. By comparison, Germany was well managed with only a 250% increase (Woods, 1993).

The Bundesbank adopted this policy and it is evidenced by the statements that have been made by the Bundesbank on numerous occasions. This belief can also be seen when evaluating the leadership of the Bundesbank. For instance, President Helmut Schlessinger was known to have the philosophy that there was no such thing as only a little inflation (de Hann, 2003, Schlessinger, 1995). Later Hans Tietmeyer who took over from Schlesinger in 1993, had the same belief, he stated that "on one thing we are all in agreement: without a stable currency there can be no lasting economic prosperity and political stability" (Tietmeyer, 1993). This policy, also influenced the confidence they have placed in it as an institution (de Hann, 2003).

This Bundesbank culture focuses on protecting the currency to enable price stability loss. Within the policy of the Bundesbank there is accepted a rate of unavoidable inflation, this is determined by the real rate of growth and changes in output prices (Kole, 1995). Therefore, stability needs to be seen in terms of 'stable money' (de Hann, 2003). Support for the policies of the Bundesbank is also seen in the statues of law, where it is stated it should; "regulate the amount of money in circulation and of credit supplied to the economy, using the monetary powers conferred on it by this Act, whit the aim of safeguarding the currency" (Bundesbank Law, paragraph 3, Lexis, 2004).

The bank is unique in this respect, as no other central banks in Europe have this clear definition of purpose within a statute, nor does the American Federal Reserve (de Hann, 2003). However, this does not mean there is no debate regarding what it means. The idea of protecting the currency has two sides, the external and the internal. Externally means the measurement of the Deutschmark against the currency of other countries internally is the price of goods and services (de Hann, 2003). These two elements have become more important since the 1960's in an increasingly global economy, and may be seen as lessons that are very important when applying the Bundesbank to the ECB.

Beginning in the 1960's there was an increasing instability of global currencies, and the issues of global value and intentional inflation had to be balanced. Many countries had rates of inflation above Germany's (de Hann, 2000). Germany was member of the Bretton Woods agreement and complained about their obligation to hold up the price of the dollar, as this was a fixed exchange rate scheme (de Hann, 2003, Cardwell, 2001). The impact of this was Deutschmark becoming too strong, increasing the money supply in Germany.

Although, the eventual demise of the Bretton Woods agreements may have been seen as bad by many economists, the Bundesbank was not moved (de Hann, 2003). It is also believed that in 1978 following the problems with the Bretton Woods agreement, when EMS was created, there was opposition on the part of the Bundesbank, but it was forced to accept due to Schmidt (de Hann, 2003). However, the policy of price stability alone is not a sufficient lesson, as seen within EMS, where France also had the same policy, but entered the crisis in 1993 (Eijffinger, 1996).

The European Monetary System (EMS) was created in March 1979. Although there were many good features of the EMS, the development was problematic and mirrored those seen in the previous Bretton Woods agreement, such as currency speculations that the central banks could not deal with. In 1993, there was an economic crisis in France and the boundaries within which the currencies operated were enlarged. There was relief on the part of the Bundesbank (Smith, 1993). Therefore, we can see there is a clear level of experience and demonstrated ability to manage the economy by the Bundesbank, independently of other countries as well as when constrained by agreements with them.

The Bank also operated differently from other banks through the use of only four tools to manage the economy, two interest rates (the discount and the Lombard rate) open market policy, and also the setting of the minimum reserve policy (de Hann, 2000). Unlike some other banks, the control is not directly on credit ceilings or interest rates; the influence is indirect as to influence the long-term of the market, and making 'fine adjustments' (de Hann, 2000).

It may be argued that in the past, the problems with the banking system were not a result of the Bundesbank's management of the economy, but because other countries were unable to meet the same standards. It could also be argued that other priorities and influences took away the Bundesbank's emphasis on their narrow-minded approach. For example, in 1993 the UK pinned the EMS, and had to withdraw as the joining price was seen by markets as too high and the pound fell. The currency could not be maintained at that level, and the result was a drastic increase in interest rates in a single day in attempts to support the currency. This day became known as Black Wednesday.

The bank also has the potential to operate utilizing other approaches. For example, there has been an approach, which favours the indirect constant influence of controlling currency stability. However, this approach initially started much lower then predicted and is still relatively low, even when it is stable. There is also the difficulty in determining if the indirect approach and long-term goal will be sufficient if major difficulties are encountered.

As you can see, the Bundesbank is an extremely complex institution. Now that we have gained a greater understanding of the Bundesbank, we can discuss the ECB and the policies that govern that institution. The following chapter will explain in detail the structure and formation of the European Central Bank.

2. Chapter

The formation and role of the European Central Bank

The European Central Bank (ECB) is the successor to the Bundesbank. However, there are many differences between this larger, newer central bank when compared to the older Bundesbank, which had a good record of accomplishment in managing the economy and maintaining price stability. The unanswered question is how the ECB will manage to fulfil the same function as successfully for Europe as the Bundesbank did for Germany.

The Bundesbank has not disappeared, but in 1998 became a branch within the ECB, this is a role of less influence (Dickhaus, 1998). This change in the banking structure has decreased the ability of Bundesbank to control the printing of money; it also leaves issues of monetary policy to the ECB (Europe Intelligence wire, 2002, Dickhaus, 1998). This restructuring has also led to some apprehension that the bank will not have the same level of success.

The way that the principles of the Bundesbank apply to the ECB is difficult to determine. The culture of the Bundesbank has been central to the success; this is a culture of not only an organisation, but also a political and economic idea, which has been established over time (Appel, 2003, Collignon, 1997). However, there are many similarities with the Bundesbank and the ECB, which is acting as its model. There is a statutory provision at the basis of the monetary union, as well as inclusion of the Maastricht treaty with the main priority being stated as the price protection. Already there is a divergence as this is price rather than currency protection.

The financial feasibility of European Monetary Union is dependent upon the European central bank, which is responsible for setting monetary policy and providing an environment that will facilitate price stability. (Barrel and Dury 2003) explain

"The European Central Bank has sole responsibility for setting the Euro Area interest rate with the prime objective of maintaining price stability in the Euro Area. As such, the ECB has to react to area wide aggregates, and not developments in individual countries. The ECB designs its policy responses for the world it thinks exists and these responses will have different costs depending on the shape of the asymmetries in response between countries across Europe. (pp 56)

In 1997 there were 172 central banks by 1998 this number had increased to 173 with the creation and inauguration of the European Central Bank (ECB) (Pringle, 2002). From the inception of economic integration and the prospect of a single currency in Europe, there was a need for a central body to control monetary policy and the currency. Although the bank was officially established in 1998, it was the culmination of many years of contemplation and policy development.

At first glance, the foundation of the ECB seems to have originated from the Bundesbank. However, the foundations of the bank can actually be found in the Delores report of 1989 (Abu Rashed et al., 1995). This report established a three-stage approach to the creation of a monetary union. It may be argued that the need for a central body prior to this date was already recognised, but this report established the responsibility of the ECB would involve "studying and proposing concrete steps leading towards this union" (Lexis, 2004).

According to the report, the three stages were laid out in very simple terms. The first stage called for increased co-operations between the member states' central banks. This included the removing of the barriers to co-operation, co-ordinating budget policies and monitoring economic policies. This stage ushered in the passing of the Maastricht treaty in 1992 (Artis, 1992).

The convergence criteria were set into motion by the Maastricht treaty, and were essential in bringing order to the economies of the various countries into the same cycle. The criteria also brought the countries into the same relative position to ensure stability within the currency once in operation. The criteria states that government spending must be controlled, the total amount of government borrowing may not exceed 60% of the GDP and the government deficit cannot be greater than 3% of GDP. As a condition of the treaty, inflation also had to be controlled and could not exceed 5% of the average of the best three countries within the EU. Additionally, the long-term interest rates had to be within 2% of the average interest rate of the same three countries with the lowest inflation rate. Prior to the circulation of the currency, there must be a minimum of two years stability within the pre-set bands in the margins set for the currency in the EMU. These were the beginnings of the economic requirements and were preparation for transferring monetary policy to the ECB (Higginson, 2004).

The second stage of the criteria prepared for inflation and the implementation of the single currency. During this stage, the European System of Central Banks (ESCB) also narrowed the bands that the different currencies could fluctuate inside the exchange rate mechanism. In addition, this stage introduced a progressive transfer of the national monetary policies to a centralised European institution.

During the third and final stage, the exchange rate is permanently fixed between the national currencies and those with the single European currency are replaced. In addition, this stage also gave the responsibility of the monetary policy to the ESCB (Begg, 2003).

The Delores report was not the first report that projected the need for an institution such as the ECB. In fact, the Delores was this built on the Werner report, but in many ways, the Werner report was not as excessive. The Werner report did not call for the same level of integration of both fiscal and monetary policies, which made it more acceptable for the member states (Welink, 1997).

The ECB was created in June 1998 with an executive board that had representatives appointed by each of the eleven members of the countries committed to joining the single European currency. The UK was not included in this process, as it had chosen to exercise the-opt-out clause negotiated in the Maastricht Treaty. Greece was not included, because it had not yet committed to European Monetary Union (EMU.

At the inception of the ECB, the first president for the ECB was Wim Duisenberg. His tenure was supposed to last until 2006, but he retired in 2003, following an announcement in 2002 that he would retire on his 68th birthday. However, his actual retirement was postponed to 31st October 2003 because his successor had to settle fraud charges before becoming the new president. Duisenberg was Dutch, and was the former head of the Dutch central bank. His successor, who was acquitted of any fraud charges in relation to the collapse of Credit Lyonnais, is Jean-Claude Trichet, the former head of Banque de France, the French central bank, a position he'd held out since 1993 (ECB, 2004).

The main purpose of the ECB is to regulate monetary policies to achieve the goals that have been dictated to the institution. These goals are established in various treaties and acts that were passed in previous years. The main goals of the ECB are established in the Maastricht treaty, as seen this was part of the first stage of the Delores report plan. Article 105.1 states that price stability is the main goal and that the system must, "support the general economies policies" (Article 105.1). The treaty also states that the other goals are secondary to the price stability goal (Noyer, 2002). The ECB also quantifies what price stability is viewed as "a year-on-year increase in consumer prices of below 2% (ECB, 2004). This can be measured with the consumer prices index of the monetary union.

However, there appears to be some difficulties with the monetary policies. One aspect that is essential to increasing market confidence and supporting monetary policy is the way policy is communicated to the market. When reviewing the tactics of the Bundesbank, the policy clearly defined the target rates. For instance, the Bundesbank would release the target growth rates for the aggregate money supply for the period, this way the markets would understand the policies that were being followed and the policies would be transparent (Feldstein, 2000). This was one of the strengths of the Bundesbank, but is not a lesson that the ECB appears to have adopted.

The Bank of England is another strong bank in the region that has been stronger in recent years, during the time the ECB was still in the developmental stages (Feldstein, 2000). The bank of England always releases its own targets in a single easy to understand form, this time the target is expressed as an inflation rate. Again, this increases transparency, increases market comprehension of the policies, and gives more confidence in the currency (Feldstein, 2000).

It seems that the ECB is unable to decide on one target and released two targets, and uses these to guide the monetary policy (Feldstein, 2000). The ECB refers to these two targets as two pillars of economic policy. (De Grauwe, 2002). Giving the targets this definition adds to the confusion because two different targets are given which creates ambiguity in the markets. This also appears to contradict the first principle of Jan Tinbergen's paradigm (Chatterji et al., 1994). Such a contradiction exists when ambiguity is made worse with the lack of information that the bank releases, regarding the way deliberations are made. The financial markets are left in limbo without a clear direction being indicated by the bank. There has also been some additional confusion, when the members speak in contradictory terms, which indicate that there is not a unified approach and signifies fundamental differences. Some members disagreed on significant factors, such as the currency's value in the international markets. Other members believed the value is important, whilst others focused on the value only to the extent that it will influence the process in the domestic areas (Feldstein, 2000). However, it may also be argued that with any new organisation there is always be teething problems (Feldstein, 2000).

The ECB does not help to rectify this situation because it does not follow the models of other central banks. For example, the Bank of the England releases minutes for meetings in which the decision regarding interest rates are made. The U.S. Federal Reserve also releases these minutes. However, despite the absence of these minutes there is a basic understanding of the processes involved.

The governing council of the ECB is made up of an executive board, which has 18 members. These members include President Jean-Claude Trichet, Lucas Papademos the Vice President, Eugenio Domingo Solans, Tommaso Padoa-Schioppa, Gertrude Tumpel-Gugerell, and Otmar Issing (ECB 2004). The remaining twelve members are the heads of the national central banks of the member states in the Eurozone (Barber and Haring, 2001).

During the initial days of the ECB, announcements would be made after the meetings regarding the resulting monetary policies (Barber and Haring, 2001). The meetings took place twice a month, which created confusion within the markets as they tried to absorb the information (Barber and Haring, 2001). Because the markets were already struggling with the 'duel pillars', the decision was made to limit the policy discussions to only once a month (Barber and Haring, 2001). It could be argued that the bank is learning from experience how to handle the markets.

Two days before a meeting is scheduled, an analysis of the monetary and economic situation is sent to the members of the governing council. This analysis is prepared by the chief economist of the ECB; Otmar Issing, and is based on the work of over 150 economists. The analysis, known as the orange book, also contains recommendations concerning the way interest rates should be handled (Barber and Haring, 2001). There are a number of informal contacts between members of the council and those close to them, where ideas may be discussed prior to the meetings (Barber and Haring, 2001).

When meetings take place, only the 18 council members, their translators and a minute taker are present. English is the official language used in the meetings (Barber and Haring, 2001). In addition, the European commissioner for economic and monetary affairs and the 12 member Eurogroup of finance ministers can also be present (Barber and Haring, 2001).

Meetings begin with a presentation by Issing, and usually last for an entire morning. All members are likely to speak. However, the format is open to interpretation as it is unknown the level of influence and the extent to which the advice of Issing is taken (Barber and Haring, 2001). However, there is a general indication that the smaller nations do not have as much influence as the larger countries (Barber and Haring, 2001).

The president will summarise the meeting, and he may propose an interest rate change if there appears to be sufficient support for a change. Majority approval is not to make the proposal, but he will move for a consensus. The desire for a consensus is high, but there is no requirement for a full consensus before a rate change takes place (Barber and Haring, 2001). The ECB contends that this does not delay the decision making process.

Although there appears to be a great deal of conflict in the ECB, there is actually no evidence of factions within the board. However, we cannot fail to notice that there is a preference of anti-inflationary preferences with France as well as Germany, Austria and the Netherlands (Barber and Haring, 2001). There have also been internal conflicts, for example in September of 2000 the president did not come to a meeting of the Eurogroup following a public argument (Barber and Haring, 2001).

There has been a concerted effort to persuade the members of the council to make fewer comments to the press, but even the president has made comments. In November of 2001, the president of the ECB commented that the press should listen to him more than it should listen to other policy makers. This comment was directed at Ernst Welteke the president of the Bundesbank (Barber and Haring, 2001).

The indication is that one of the most problematic aspects of this bank is accountability (Walsh, 2003, Forder, 2002). This disregard for accountability is a divergence from the model of the Bundesbank, and indeed many other banks. In general terms, any central bank needs to be held accountable for the actions it pursues (Pringle, 2002, Randzio-Plath and Padoa-Schioppa 2000, Padoa-Schioppa 1999). Correcting this problem should begin with a legislative mandate under which the bank operates. This mandate should involve price stability below 2% inflation over the medium term. Where there is a single goal this is simpler, and when we consider the way the ECB has to balance the needs of all members, the situation is more complex. (Heisenberg, 2003).

At the end of the day the bank should, be accountable to the public, however, in terms of direct accountability we can argue that none exists for the ECB. On the other hand, if the bank is to be accountable to the public, then the only alternative may be to appoint a representative of the public and the parliament. For example, in the United States, the Federal Reserve is accountable to Congress (Debelle, 1994). However, the ECB does not have this type of structure, because it was created to be an independent entity. This structure is one of the cornerstones that the bank had learnt from the Bundesbank (Radzio-Plath and Padoa-Schioppa 2000).

In terms of whom the bank should be accountable to, the European Parliament may appear to be the logical choice, as this is the only institution that has a direct mandate from the citizens. The difficulty with this idea lies in the fact that the bank is structured so that it is not accountable to parliament. For example, the governing council has sole control over the various monetary tools, and it cannot take advice from any of the euro governments.

This strategy is used to retain independence and to prevent interference with economic decisions. The ability to maintain independence can even be seen in the way the board members are appointed for a none-renewable term as a tool by which they are protected from political interference. As such, the independence is guaranteed and a lack of accountability was created.

When we combine this with the lack of transparency with the fact that minute meetings are not released there are still many areas that can create market confusion and lack of confidence. The lack of real accountability, transparency and clear agreement may also be aspects the ECB needs to consider as areas for improvement. In addition, these are areas where the ECB can learn many lessons from the Bundesbank.

There are also guarantees that the ECB will be independent. However, when we look at the governing board of the ECB, which is composed of the members of the nation state central banks, interests may be represented, but the culture and way the economic policy is enacted in each country may be different. This may dilute the message of the Bundesbank model on which the organisation is based.

There is the possibility that the Bundesbank model will be adhered to and model followed. However, there is also scope and flexibility for departure from the methodologies and policies that were used in realising the goals that formed a part of the culture of the Bundesbank. Due to the political background of the Bundesbank, these methodologies and policies are not seen in other central banks.

However, with the appointment of a new president, the increased attention on inflation rates and the targets becoming more focused there is the potential of the bank to reduce the uncertainty and increase the clarity that is needed in the markets. This will help increase confidence in the markets and allow the bank to control the current problem of inflation with less market volatility, which is created by speculation.

3. Methodology

The European Union (EU) is the largest single market. Not all members are participating in the single currency, but for the twelve member states that currently use the Euro as their currency; the European Central Bank (ECB) is the central bank responsible for setting the monetary policy on which the respective economies will rely. This is a huge responsibility for the ECB and this responsibility is likely to increase. On May 1st 2004 an additional ten countries joined the EU, increasing membership to twenty-five, many of these countries have already expressed an interest in adopting the single currency as soon as possible. The year 2007 is generally viewed as the earliest likely date for these new EU members to join the Eurozone (Van Arnum, 2004).

The establishment of economic criteria has aided in ensuring stability to ease the difficulties that the ECB faces when managing such a broad and diverse economy. The need to manage interest rates to promote growth in all areas without creating economic shock and allowing for the control of inflation is difficult: especially in an environment where the confidence of the public and markets are of such influence.

In the past, the Bundesbank has been a well-managed central bank, able to manage the German economy, guiding it through difficult times (Kole, 1995, Uwe, 1994). The bank was also well respected and the polices of the bank were often emulated by other countries to improve their own economies. (DeHann, 2003, Frowen, 1998). It is argued that the ECB should have learnt from the examples of the Bundesbank (De Haan, 2000). If the ECB is able to draw on the knowledge of the Bundesbank and the knowledge from members of the bank's board. The combination of these two factors should contribute to the development of a well-managed bank.

In examining the ECB and if the bank is able to operate with the same level of efficiency as the Bundesbank, our methodology will involve a careful review of the Bundesbank. The research will provide a detailed explanation of the culture, policies and operation of the Bundesbank. The research then focuses on the structure and operation of the ECB.

The examination of the current situation will require an understanding of the history of these institutions. This use of a case study provides an in-depth analysis of the situation, but there is also the need to accept and allow for any bias on the part of the researcher (Smeltzer, 1997). The initial research will be a comprehensive literature review to give the reader and the researcher grounding in the area and an understanding of research already conducted (Miles and Huberman, 1994). The research process is frivolous if the researcher is merely emulating or repeating research that has already been conducted (Denzin, 1978).

During this initial stage, information will be obtained primarily from secondary sources; current information will be obtained from academic journals or periodicals (Bates, 1996, Stake, 1995). The historical information is more likely to be represented accurately and in greater depth in books (Stake, 1995).

The printed data need not be the only sources; the internet is also a wealth of information. Electronic databases can provide access to accredited searchable databases to publications that are published in other countries. Web pages may also be useful, for example, the European Central Bank has an official website that provides valuable information. However, anytime that information is taken from any source other than official web sites this information will need to be verified due to the high potential of unreliable information.

The research will be directed at the policies and operations of the banks that manage the economy, such as the goals of price stability (Noye, 2003). For the Bundesbank this is well documented, but for the ECB this will require meticulous research as there is still a great deal of secrecy surrounding the meetings of the board (Heisenberg, 2000, Jakob and De Hann, 2000). The research will not only view the way policies are determined and acted upon, but also on the speeches and comments made by the members of the board; as these are all factors that influence public perception of the bank. This is particularly true of a new organisation that has not yet earned public credibility (Theaker, 2001).

The data can then be gathered together to allow a comparison to be made between the operation and polices of the Bundesbank and the ECB. In addition, the collection of this data is necessary to identify the differences and similarities. Direct comparisons can then be made and their validity can be verified (Brewer and Hunter, 1989). The contrast may be a direct policy for policy comparison; however, this may also be scaled, with some type of scoring basis or Table produced to indicate areas of commonality and divergence. This will increase the ease of understanding to readers and place the data into a concise and usable format.

The research will also make use of primary data, which may be taken directly form the ECB and EU web cites. It may also be obtained from publications, where performance indicators are used and policy is outlined from speeches and from general statistics table. However, this alone will only give an indication of the performance of the ECB and its policies, not perception and current information.

Two types of research are used to gather data. Quantitative research relies on a large amount of results recorded data is often numerical. This type of research is suitable as a method of determining cause and effect relationships (Creswell, 2002). The methodologies will often be based on scientific procedures of investigation. Quantitative research includes descriptive, correlational, quasi-experimental and experimental (Creswell, 2002).

Qualitative research is narrower and more concentrated. This type of research views in-depth information from a smaller quantity of subjects (Creswell, 2002). Often this research will be word-based with methods such as recorded in-depth interviews and other data, which is not easily classified (Creswell, 2002). Qualitative research is best suited to phenomenological research grounded theory, ethnographic and historical research (Creswell, 2002).

Interviews will be used in this study for several reasons. Although there is an argument for quantitative research, approaching a large number of people for responses to a questionnaire, or the gathering of large quantities of data, as a case study the in-depth information is deemed more appropriate. There are also budget and time limitations, which also bias the project towards the use of interviews.

The interviews will be structured with both closed questions to allow for the classification of the subjects and any data that needs to be categorised. Open-ended questions will be included to allow for genuine responses and indicate areas of concern. Whilst it would be advantageous if members of the Bundesbank or the ECB could be interviewed this is unlikely due to the many barriers. There would also need to be interviews with several members of the banks to gain a balance.

As the banks success in running the economy also relies on the confidence that the markets and consumers have in the bank, there is also a need to explore this aspect of the banks success. The use of interviews could then be undertaken with individuals working in the money markets to assess their opinions of both banks performance and how they compare. Additionally, interviewees may be members of the public that have an awareness of the money markets and the role of the ECB. The ideal subjects may be those living within the Eurozone, but this is not essential.

Interviews will need to be structured, beginning with general questions to assess the knowledge of the respondent, and then moving onto the perception of the Bundesbank and the ECB, only at the end asking for any views as a comparison. The interviews will also be recorded so that notes can be taken later and to evidence the responses. Questions will concern the perception of the economic and political performance (past present and potential future), efficiently, professionalism, accountability and openness and any other factors, which are indicated by the literature review.

The interviews can then be used to ascertain common responses. In addition, in-depth results programmes such as SPSS may be utilized for a statistical analysis and potential hypothesis testing. The perceptions can then be compared with the actual performance of the banks to see if there is any correlation between perceptions and actual performance. This may be assessed not only though the inflation rates, as indicated by the goal of price stability, positive publicity, and the value of the Euro. The interaction that would favour the interviews with those in the money market, as any correlation is likely to be more visible (Lunt, 1996). The results can then be presented in a dissertation format, giving a good solid background to all the factors and assessing the way that the ECB is performing in a range of aspects and comparing this to the Bundesbank.

4. Literature review

1.

Introduction

The current role of the Central Banks is still developing with many arguing that current tasks are inadequate in most banks, despite the model of the Bundesbank. Both Bob Mundell and Milton Freidman agree that when it comes to managing monetary policy the overall record of central banks is very poor (Dowd, 2001). Although it may be argued, the Bank of England has not had the chance to prove its efficacy, only gaining independence in the late twentieth century. During an unprecedented expansion of central banks, there was also an unprecedented century of inflation, which caused very serious economic and social impact (Dowd, 2001). The argument has been made that central banking is incompatible with monetary stability (Dowd, 2001). For any bank that wants to develop and meet the goals with the same success as the Bundesbank, the lessons of the past need to be understood, part of this means understanding how and why central banks have developed within their current models.

2. The Development of Central Banks

Central banks have been in existence for centuries, but the role and operation has differed greatly. Central banking texts often look to the beginning of central banking at the end of the seventeenth century with the creation of the Bank of England

. The evidence of Britain's superior economic, financial and military being credited, in part at least, to the creation and operation of the central bank (Weingast, 1992, North and Weingast, 1989). The Bank of England, with its long history makes a good case study to look at the role and development of central banks.

However, to garner a true appreciation of the history of the Bank of England we need to go back to 1609, when the Amsterdam Wisselbank was created. The Amsterdam Wisselbank lent to the city of Amsterdam, the lending consisted of the Dutch East India Company and the province of Holland (Bank of England, 2004). The Amsterdam Wisselbank was also responsible for the coinage and the exchange rates. It was not until 1683 that the bank was able to lend to private customers (Bank of England, 2004).

The seventeenth century in England was a time of growing commerce with new ideas occurring all the time, so much so that this was referred to as the "age of projects" (Bank of England, 2004). The trade was increasing rapidly but to increase further there was a need for a cash injection or a money fund to increase the liquidity of the economy. The model of the Dutch was seen as a benchmark, as it had fulfilled the same needs and created strong economic growth in the Netherlands (Bank of England, 2004).

The arguments for a national bank increased after the revolution when, in 1688 William of Orange along with Queen Mary came to the throne (Philips, 1997). Petty argued for the creation of a credit-based trading system. He believed that such a system would increase the level of trade the nation could undertake and increase the sphere of influence (Bank of England, 2004, Philips, 1997). William Petty wrote

"What remedy is there if we have too little money? We must erect a Bank, which well computed doth almost double the Effect of our coined Money; and we have in England Materials for a Bank which shall furnish Stock enough to drive the Trade of the whole Commercial World" (quoted Bank of England, 2004).

There was, underlying this rhetoric, a desire to create a scenario where England would be able to help the Dutch in the war against the French (Bank of England, 2004, Philips, 1997). The development of the idea was only pursued following several rejections of the plan put forward by William Paterson. The first rejection occurred in 1691. There were a great many barriers created by fear and misunderstanding. In 1695, William Paterson wrote; " Others said this project came from Holland and therefore would not hear of it, since we had too many Dutch things already" (quoted Bank of England, 2004).

The initial idea was for a £1 million loan to be made and in return, the institution would be able to issue notes that would be legal tender, indicating a potential role in monetary policy. This was rejected, and history shows us this was an idea that was a century ahead of its time. The eventual acceptance was for a plan which put forward the model of a 'Fund for Perpetual Interest' provided through a 'Bank of England' (Moncrief-Scott, 2000). At this time, the terms bills were not included (Duggleby, 2002). This plan had a better chance of acceptance once it had the support of the Chancellor of the Exchequer, Charles Montagu, who challenged the parliamentary lobbying to allow this plan to be accepted. The second key supporter was an important merchant Michael Godfrey, who challenged the city to accept the plan.

In addition, there was the need for government provided funds. A key issue was the need to raise funds for war. Where monarchs are to wage war, they need financing to support this action (Root, 1994). However, where funds are limited there is a constraint placed on the actions of the monarch by the citizens and the fear of citizens that Monarchs may take advantage of their position to default on the loans. The default could take place with impunity when the war ended (Moncrief-Scott, 2000, Root, 1994).

The problem existed when monarchs suffered from a lack of credibility and a lack of consistency. The difficulty was their inability to commit in a credible fashion to repay debt or promises made in respect to property damaged due to the impact of war. This constrained the monarch and their ability to raise any credit times of war (Root, 1994, North and Weingast, 1989).

A solution to this dilemma was for the delegation of the monarch to raise credit through Parliament and the use of a central bank (Moncrief-Scott, 2000, Root, 1994). This creates an increased credibility over the repayment of loans after a war. The power of the decision to repay or default was relinquished and authority over lending decisions was handed to the parliament. Parliament was made up of representatives of the population, although in a far more limited and constrained manner than today. This meant that the representatives of the wealthy patrons, who would make the loans, were able to have a veto on the way loans could or could not default (Moncrief-Scott, 2000).

To establish a system that could operate in this fashion there was the need for a central institution. As Dickson and Sperling (1970) state,

"In view of its services to the stability of public finance and the improvement of public borrowing from the year of its foundation, it is hard to resist the conclusion that no institution contributed more to the stability of the Revolution settlement or underwrote more effectively the liberties that Englishmen enjoyed during the eighteenth century " (Dickson and Sperling, 1970).

The property rights of the investors were protected explicitly and a commitment was given to the incorporation of technology into the banking institution (Hicks, 1969, Macaulay, 1831). The innovation of the Bank of England was the charter that was created, placing the Bank of England in a dominant position where in the management of governmental finances (Moncrief-Scott, 2000). The lending to the government was therefore centralised in a single body and as such created a private constraint that represented a change in the way lending and borrowing took place (Moncrief-Scott, 2000). The resulting British hegemony that occurred after this was the British Empire's domination of the trading world (Wilson, 2004).

The different perspective that was now given to lending to the government reflected the better credit worthiness. A major benefit was the stabilising influence that the Bank was able to create by smoothing the distortions that occurred because of war. The bank was able to creating a tax smoothing policy and allowed growth to take place during war when expenditures were very high and in times of peace when expenditures decreased. (Ferguson, 2004). Debts were increased during wartime and then the debt was paid off with the tax over several years. The ability to spread the cost of war also reduced the cost of raising finance as the risk was less; the Bank constrained the use of opportunism by the government and reduced the economic strain of war (Moncrief-Scott, 2000, Sargent and Velde, 1995). This gives us a very strong indication of the original purpose of the Bank of England. The primary focus of the bank was to expand trade by creating credit and to allow the funding of wars.

With the Royal Charter, the Bank of England is set up with a loan of £1,200,000 in 1696, as it was the banker to the government. The bank managed the recoinage of 1696 bearing the cost itself; the bank was also a commercial lender, dealing with bills, which were the equivalent of overdraft facilities. The role gradually increased with the creation of the credit facilities and as such, there was the impact of doubling the effect of the coined money (Bank of England, 2004). The bank is increasing monetary stability, but the policy is lacking both at the government level as well as at the banking level.

Credit was seen as 'imaginary money' and the original ideas of economists such as William Petty (Bank of England, 2004). This was also being accompanied by a changing concept of money, which had been seen as needing physical coinage to be viable. The idea was that money could exist without need of a physical coin, but could still have an underlying asset to support the funds. This concept lubricated the economy and allowing transactions to take place more rapidly. This meant that as the theory entered into common practice and national debt was created the final ingredient to the equation also came about, the use of paper money to represent that credit (Bank of England, 2004, Moncrief-Scott, 2000).

During the eighteenth century, the role as government banker was dominant. The National debt grew at a rapid rate, in 1700, it was £12 million and by 1815, it had increased to £850 million (Moncrief-Scott, 2000). Napoleon was defeated at Waterloo in this year. The Bank of England was able to fund this war. The reliance on the Bank of England meant that when the Charter had was renewed in 1781, Lord North, the Prime Minister described the Bank of England as

"from long habit and usage of many years ... A part of the constitution ... To all important purposes the public exchequer ... done at the Bank, and as experiences had proved, with much greater advantage to the public, then when it had formerly been done at the Exchequer" (Bank of England, 2004).

During this era, the Bank took risks. They had been creating credit in the economy, but this was not all backed up by deposits of gold in the reserves, which could prove to be detrimental (Bank of England, 2004). If all of the depositors wanted to withdraw their money from the bank at the same time, the bank would have failed (Bank of England, 2004).

History shows us this was not the case, but there were times when there were difficulties and these problems may have resurfaced had events taken a different turn (Bank of England, 2004). For example, in 1745 there was a run, but the bank was paying out funds in sixpences and the reserves were almost totally depleted during the Jacobite advance (Bank of England, 2004).

This increased the realisation that there was a need for some type of monetary target so that credit creation did not occur too rapidly and increase this risk. There was a need to retain a prudent level of gold in reserve. The development of the bank and the increased knowledge may be credited with giving rise to the realisation that monetary policy was needed. From this, we see the emergence of the first policy that has remained constant ever since, the need for the central bank to create and maintain monetary stability (Bank of England, 2004).

However, even prudence and a careful decision-making process may not be enough when the role as government banker is put under more pressure, when the need for finances to fund war occurs. In 1793, the beginning of a 22-year war period starts (Bank of England, 2004). In 1797, there was the need to protect the reserves because of support for the war, at which time the 'restriction period' occurs. This is a time during which the bank notes are not convertible, this lasted for six years following the end of the war, lasting until 1821 (Bank of England, 2004). This is an emergence of a monetary policy being created to prevent inflation and control the economy, but the government, and not the bank is responsible for this.

There was also a shortage of coins during this period, so to maintain monetary stability notes were issues to the value of £1 and £2. However, there is a problem associated with central banking as inflation increased and it was determined by a Parliamentary Select Committee that the cause had been an over issuance of notes (Moncrief-Scott, 2000). The argument was that if paper money was no longer convertible, then to retain the value of the paper money the supply had to be limited, a concept well understood today (Bank of England, 2004, Nellis and Parker, 2000). At this time, there is an emergence of the Monetarist school of thought and the government starts to embrace monetary policy.

During 1825, there was a stock market crash and between 1825 and 1826, there was a systematic stoppage of the banking system. In addition, a large number of business failures and bankruptcies were seen. If we wish to evidence this, we can review the records of the time where the number of bankruptcies recorded gives the levels for the period surrounding 1926.

The figures available in Appendix A, give a clear indication of the state of the economy at this time and the lack of stability. The difficulties may have been worsened by the transition from the wartime economy to a peacetime economy. This was a lesson that could have been useful when the country emerged in the next century from the First World War, but were not considered (Bank of England, 2004).

However, we can also argue that the problem was not only that of the Bank of England, many smaller banks were also issuing their own bills or bank notes, many of which did not have the same security as the Bank of England notes. When the non-convertibility of notes was rescinded many of these smaller banks subsequently failed due to their lack of resources. The difficulties were summarised by a contemporary critic of the Bank of England, William Cobbett; "The Bank is blamed for putting out paper and causing high prices; and blamed at the same time for not putting out paper to accommodate merchants and keep them from breaking, It cannot be to blame for both and indeed is blameable for neither. It is the fellows that put out the paper and then break that do the mishchief." (quoted Bank of England, 2004).

In 1826 the Country Bankers Act was passed This act established some of the privileges of the Bank of England making it possible for joint stock banks to be created with more than six partners and also a proviso that they could not be within a sixty five mile boundary of London (Bank of England, 2004). By 1833, the notes over £5 from the Bank of England became legal tender and increased the confidence of the bank (Bank of England, 2004).

The increased stability that was created by the different small changes in policy all worked to create stability in the long as well as the short-term. The use of the Gold standard has also been a tool used by Bank of England to create stability. One criticism has been the way, when abandoned, in the nineteenth and twentieth century, there has been a return to instability. However, we can also argue that unlike the Bundesbank, the long-term existence may give rise to lessons, which the Bundesbank learnt, from observation.

The tools that have been used over time to create stability are interesting. One of the oldest tools has been the use of different standards; we see this in the eighteen century and intermittently to the twentieth century. The first of these was under the 1844 Bank Charter Act when the bank was taken a step closer to having a monopoly on the creation of bank notes. The first step towards a gold standard was the Acts requirement that any capital above £14 million had to be backed by gold, either in coinage or in bullion (Bank of England, 2004). After this the bank takes on the responsibly it has been influential in, the creation of monetary stability. This may have been a goal before, but the responsibility was that of government banker, this is therefore new in terms of responsibility.

There were times when the 1844 act had to be suspended due to crises, such as in 1866 when a well-known city house failed; Overend Gurney (Bank of England, 2004). This brought about a new era as the Bank of England as Steward, as seen later in 1890 when the Baring Brothers faced a threat and the bank was rescued by a guarantee issued by the Governor of the Bank of England. As such, we see the responsibility taken for the banking industry for a while. It is worth comparing this with the problems faced in the twentieth century when Nick Leeson brought down Barings Bank, and this time the Bank of England did not save the bank.

The gold standard is worth greater consideration as this was a tool that created stability by several central banks working together and as such may be seen as a very credible consideration for the study of a European central bank. The gold standard was a system where the different currencies were linked not to each other, but to the price of gold. For example at one point the gold price was set in dollars at $20.67 for one ounce, whereas the United Kingdom set the rate at 77 shillings and 10 1/2 old pence. As these were the days before decimalization (Anonymous, 2001). This was not quite so straight forward as there was an adjustment included in here because the United Kingdom gold had a purity of 91.7, whilst United States gold was only 90% pure. The actual outcome was a fixed rate of $4.55 to the £1 (Anonymous, 2001).

However, we can see how the impact of this was to fix the currencies against each other, as such, it may have been a tool against inflation and currency crisis as it takes the speculation out of the market. Nevertheless, it does not itself eliminate all risks from the economy, and as we consider this further, we can even argue that it brings in the risk of wider economic problems and reduces the acceptability or reliability of gold as a hedge against inflation (Anonymous, 2001).

In many ways, these were some of the most productive years in terms of international trade and international currency stability. However, there were problems with this system. For instance, during the period of the systems active usage there was a reduction for gold held by the U.S. Federal Reserve (Anonymous, 2001). More gold was leaving the country than was entering it, and as this was the only country with the direct link to the gold, this was seen as a potential cause for problems. By 1967 the gold reserves held by the United States were only 50% of their 1944 level, and as such the fixed dollar to gold rate was unsustainable if it were to be tested (Anonymous, 2001). There were many attempts to patch the system up, as it was in everyone's interest to keep the system going, but in the end, it collapsed (Anonymous, 2001).

At the same time as the Bretton Woods agreement, the emergence of nationalisation of the Bank of England was also apparent. This made little real impact on the operations but left the door open for many later moves. The development of the EU and the need for central bank independence has also been seen in the history of the Bank of England. The Bank of England was under the control of the government. Once national policy was to use interest rates as a tool to control inflation and the final decisions as to whether or not interest rates would increase was seen as residing with the government, and not the bank. Therefore, the bank was in many ways merely a supplementary department of the government. It was only in 1997 that the Bank of England was granted the freedom to make its own decisions regarding monetary policy and interest rates, which was enacted under the 1998 Bank of England Act (Lexis, 2004). Therefore, we can argue that the independence of the Bank of England was protected by legislation.

At this point, the Bank of England takes on the responsibility of monetary policy. Prior to this, monetary policy along with fiscal policy composed the government's overall macroeconomic policy. Realising that the country would enter the single currency system necessitated the independence of the central bank. However, the bank's independence in setting monetary policy is limited. The Act limits the goals, as it states that the inflation target of the government will be set at about 2% and the Bank of England then has to support the economic policy of the government. Therefore, the target is set by the government and the bank merely has to seek to meet that target. It is also worth noting that the same Act also stripped the bank of some duties, moving the management of the government's debt back to the treasury, lessening the role of the manager of the government's finances (Tootell, 2002).

The tools of monetary control may have been altered, but its' use has changed little in practice. The interest rate target for the bank is the fourteen-day maturities; the mechanism for this is easy to understand. There are reserve levels that are virtually nil and all accounts with the banks have to be settled at the end of each day ( Tootell, 2002). The Bank of England can use this as a tool to ensure there is a shortage of reserves, and as such, the banks then need to gain liquidity form the Bank of England. The Bank sets a rate at which it will lend to the market to increase or decrease this liquidity (Tootell, 2002).

This exercise takes place several times a day. . In the morning there is an estimate made by the Bank of England regarding the day's shortfall in liquidity. The bank will also state the rate at which it is prepared to purchase securities at the amount that is required to meet the shortfall. If there is a greater demand than estimated, there will be a pro-rata of the bids across all the counterparties assets by their bid and assets offered. Where the opposite occurs and there is a surplus liquidity, there will be the use of delivery by value of the gilts seen as reverse repo in the markets (Tootell, 2002). Unlike other countries, there is not a discount window for the use f banks at their discretion.

This was not used as extensively until recently as the repo market was very limited and constrained. The assets accepted by the Bank of England were very short-term, such as local authority bills and short-term treasury bills, but these were once outright purchases or sales. In 1997, the banking statistics on the acceptance of longer-term bills and purchases were representing a smaller level of the overall market. Then, in October 1998, foreign government debt in sterling as well as debt from major international institutions that were issued in the UK, became acceptable, increasing the market further. In 1999, more changes occurred with the inclusion of bonds that were in sterling from international agencies as well as other EU governments and assets in Euros.

In 2000, there were more expansionary changes. For instance, real bills, meaning bills that were backed by a 'self liquidating transaction' were included in the system (Tootell, 2002). Now this has been liberalised, and creditworthiness alone is able to provide collateral for a bill (Tootell, 2002). It may be argued that many of the changes in Europe, such as the creation of the ECB and increasing trade has forced change, but also that the Bank of England, is also able to respond more effectively with visible and less visible monetary tools.

The change was partly forced upon the government due to the unification Europe and the requirement for independent national banks. However, the government still had a veto on the Bank of England's decisions to be used in extraordinary circumstances and as such, we can argue that the independence is limited by this factor because the decisions that the government makes may be contradictory to the bank's decision. It is looking at the more visible aspect of base rates and monetary policy that this can be seen. Some argue that the current impedance is not as great as seen in other nations as there are also regular 'policy' meetings between the government and the Bank of England. Therefore, it would be naive to believe that political pressure is not does not play a role in the banks policy. These regular meetings take place monthly between the governor of the Bank of England and the Chancellor of the Exchequer, who is a member of the government. However, although the Bank is independent it has the task of seeking to meet the government targets for growth and inflation using monetary tools.

The decisions regarding policy, including the price stability and interest rates are not made by one person, but by the monetary policy committee (MPC) (Bank of England, 2004). The committee meets monthly to examine the state of the economy, and take a vote as to whether interest rates should be changed. The committee consists of profession experts who are qualified to make these decisions and assess the implications of their decision. The action taken will coincide with a straightforward majority.

The student may conclude that this is a democratic method of deciding the policy with the experts being in control and not the government; however, this is not the case. The role of the monetary policy committee (MPC) is maintenance of price stability, but they are obliged to do this within government inflation targets (Bank of England, 2004). In addition, the committee is bound to support the government policy on employment and growth in the economy (Bank of England, 2004). Therefore, the independence is limited because goals are set for the bank, but the way that they reach these goals appears to have a degree of discretion.

The treasury can also be present at these meetings, but does not have the right to vote. Therefore, the role it plays may be a persuasive role, but not one that is directly involved in the decision making process (Bank of England, 2004). The independence of the committee appears pressured, but with the legislative protection for its' independent status apart from short periods in extreme circumstances it is starting to appear more independent. It is now apparent that their control is more subtle as it is likely that although experts are sought, the economists chosen are likely to be those with views similar to the government (Money Marketing, 2000). However, we can also argue that there have been sufficient years between 1997 and the present to demonstrate that the independence is real and that the members of the committee do not appear to bow to political pressure.