Chapter 15 Parks Econ104 The Federal Reserve and Monetary Policy

Chapter 15Parks Econ104

The Federal Reserve and Monetary PolicyThe Federal Reserve and Monetary Policy

The Federal Reserve

• The Federal Reserve is the United States Central Bank.

• Founded in 1913 after four severe banking panics.

• Chartered by the federal government but is largely independent of the authority of the Congress and President.

• Primary role is to conduct monetary policy and to act as a lender of the last resort to banks to stabilize the financial system.

• The Federal Reserve is the United States Central Bank.

• Founded in 1913 after four severe banking panics.

• Chartered by the federal government but is largely independent of the authority of the Congress and President.

• Primary role is to conduct monetary policy and to act as a lender of the last resort to banks to stabilize the financial system.

Structure of the Fed

• The unique structure of the Federal Reserve is a consequence of history and politics.

• The unique structure of the Federal Reserve is a consequence of history and politics.


• The Board of Governors– is the highest governing body of the Federal

Reserve.– It consists of seven members including the

chairperson--currently Ben S Bernanke.

• The Twelve District Banks provide regional check clearing, bank supervision, payments processing, and economic analysis.

• The Board of Governors– is the highest governing body of the Federal

Reserve.– It consists of seven members including the

chairperson--currently Ben S Bernanke.

• The Twelve District Banks provide regional check clearing, bank supervision, payments processing, and economic analysis.

© OnlineTexts.com p. 5

• http://www.federalreserve.gorve.gov/aboutthefed/default.htm

• http://www.federalreserve.gorve.gov/aboutthefed/default.htm









• The F.O.M.C. (Federal Open Market Committee)– is responsible for directing monetary policy.– consists of 12 members, the seven from the Board

of Governors plus five Presidents of the District Banks who serve on a rotating basis, one of which is always from the New York Fed.

– meets about every six weeks to discuss monetary policy and decide what course of action to take.

• The F.O.M.C. (Federal Open Market Committee)– is responsible for directing monetary policy.– consists of 12 members, the seven from the Board

of Governors plus five Presidents of the District Banks who serve on a rotating basis, one of which is always from the New York Fed.

– meets about every six weeks to discuss monetary policy and decide what course of action to take.




http://www.federalreserve.gov/monetarypolicy/fomc.htm#calendars

http://www.federalreserve.gov/monetarypolicy/fomc.htm#calendars

Tools of Monetary Policy

• The Federal Reserve's attempt at stabilization policy is referred to as monetary policy.

• Tool include:1. Open Market Operations (OMO),

2. Change in the discount rate, and

3. Change in the reserve requirement ratio.

4. other stuff

• The Federal Reserve's attempt at stabilization policy is referred to as monetary policy.

• Tool include:1. Open Market Operations (OMO),

2. Change in the discount rate, and

3. Change in the reserve requirement ratio.

4. other stuff

Tool #1: Open Market Operations

• An Open Market Operation is– the Fed's purchase (open market purchase) or sale

(open market sale) of government securities via transactions in the open market.

– by far the most important tool of the Fed and it is used daily to target the federal funds rate.

– An open market operation impacts the banking system by changing bank reserves initially and, ultimately, the money supply.

• An Open Market Operation is– the Fed's purchase (open market purchase) or sale

(open market sale) of government securities via transactions in the open market.

– by far the most important tool of the Fed and it is used daily to target the federal funds rate.

– An open market operation impacts the banking system by changing bank reserves initially and, ultimately, the money supply.

Tool #1: Open Market Operations

•Example: the Fed purchases $100 million of government securities from commercial banks.

•Example: the Fed purchases $100 million of government securities from commercial banks.


• Expansionary monetary policyBuy BONDS With RESERVES – increasing reserves which increases excess reserveswhich allows increased loans.

• BUY BONDS – Bid price of bond up, lowers interest rate

• BUY BONDS – increases money supply lowering interest rate

• Expansionary monetary policyBuy BONDS With RESERVES – increasing reserves which increases excess reserveswhich allows increased loans.

• BUY BONDS – Bid price of bond up, lowers interest rate

• BUY BONDS – increases money supply lowering interest rate


• Contractionary monetary policySell BONDS – decreases reserves because in the end reserves must be used to pay for the bonds that the FED sellsSell BONDS – lowers price of bonds, increasing interest ratesSell BONDS – decreases the money supply raising interest rates

• Contractionary monetary policySell BONDS – decreases reserves because in the end reserves must be used to pay for the bonds that the FED sellsSell BONDS – lowers price of bonds, increasing interest ratesSell BONDS – decreases the money supply raising interest rates




Where did the Fed get $$ to buy bonds

• The central bank can CREATE reserves.

• NOTE – the FED was limited to buying US Treasuries but now it can ‘buy’ other stuff such as the junk at Bear-Stearns, AIG, CITI-GROUP. It could buy anything to increase the money supply/lower interest rates but it can only sell what it has.

• The central bank can CREATE reserves.

• NOTE – the FED was limited to buying US Treasuries but now it can ‘buy’ other stuff such as the junk at Bear-Stearns, AIG, CITI-GROUP. It could buy anything to increase the money supply/lower interest rates but it can only sell what it has.


http://www.federalreserve.gov/newsevents/recentactions.htm

http://www.federalreserve.gov/newsevents/recentactions.htm




Tool #2: Change in the Discount Rate

• The discount window is where depository institutions go to borrow funds from the Fed.– The discount rate is the interest rate at which the

Federal Reserve lends funds to banks.– Borrowings from the discount window are short-

term, usually lasting only a week or two.– Changes to the system were implemented recently,

establishing primary credit and secondary credit programs.

• The discount window is where depository institutions go to borrow funds from the Fed.– The discount rate is the interest rate at which the

Federal Reserve lends funds to banks.– Borrowings from the discount window are short-

term, usually lasting only a week or two.– Changes to the system were implemented recently,

establishing primary credit and secondary credit programs.

Tool #2: Change in the Discount Rate

• Suppose the Fed decreases the discount rate by one percentage point, say, from six percent to five percent. This change induces banks to borrow $5 million more in reserves from the Fed to fund additional loan opportunities.

• Suppose the Fed decreases the discount rate by one percentage point, say, from six percent to five percent. This change induces banks to borrow $5 million more in reserves from the Fed to fund additional loan opportunities.


• The discount rate is changed when the Fed Funds Rate target is changed and the discount rate is generally lower.

• The discount rate is changed when the Fed Funds Rate target is changed and the discount rate is generally lower.

Tool #3: Change in the Required Reserve Ratio

• The required reserve ratio is the minimum amount of reserves that a bank must hold relative to its deposit base.– Reserves include vault cash and reserves held at the

Federal Reserve.– Currently in the U.S. banking system, the required

reserve ratio is 10 percent.– Lowering the ratio frees up reserves, while raising

the ratio reduces reserves.

• The required reserve ratio is the minimum amount of reserves that a bank must hold relative to its deposit base.– Reserves include vault cash and reserves held at the

Federal Reserve.– Currently in the U.S. banking system, the required

reserve ratio is 10 percent.– Lowering the ratio frees up reserves, while raising

the ratio reduces reserves.

Tool #3: Change in the Required Reserve Ratio

• Example: the Fed lowers the required reserve ratio from 12.5 percent to 10 percent, freeing up $2,500 in excess reserves.

• Example: the Fed lowers the required reserve ratio from 12.5 percent to 10 percent, freeing up $2,500 in excess reserves.


2006

0% of first 8.5 mill

3% up to 48.5 mill

10% over 48.5 mill

At times the 48.5 is changed a bit.

1990-1991 was 12% r.t. 10% - lowered req. res. by 8.9 billion. Fed also reduced to 0% reserves for CDs reducing req res by 13 billion

2006

0% of first 8.5 mill

3% up to 48.5 mill

10% over 48.5 mill

At times the 48.5 is changed a bit.

1990-1991 was 12% r.t. 10% - lowered req. res. by 8.9 billion. Fed also reduced to 0% reserves for CDs reducing req res by 13 billion

Summary of Monetary Policy Tools


• Linkshttp://wfhummel.cnchost.com/linkshistoricaldata.html

• http://www.federalreserve.gov/releases/Z1/Current/z1r-4.pdf

has the balance sheets for many sectors including the Fed Res at page 68. Page 88 is cool to see more debt that is not reported (agency debt). Page 94 home mortgages.

http://www.federalreserve.gov/releases/h41/Current/h41.pdf

• Linkshttp://wfhummel.cnchost.com/linkshistoricaldata.html

• http://www.federalreserve.gov/releases/Z1/Current/z1r-4.pdf

has the balance sheets for many sectors including the Fed Res at page 68. Page 88 is cool to see more debt that is not reported (agency debt). Page 94 home mortgages.

http://www.federalreserve.gov/releases/h41/Current/h41.pdf



Impacts of Monetary Policy on the Economy

• How do Federal Reserve actions impact the behavior of output, inflation, and unemployment?

• Monetary policy ultimately works by changing interest rates in the loanable funds market, which change the level of demand for goods and services in the economy OR changing the amount of credit ‘easily available’.

• How do Federal Reserve actions impact the behavior of output, inflation, and unemployment?

• Monetary policy ultimately works by changing interest rates in the loanable funds market, which change the level of demand for goods and services in the economy OR changing the amount of credit ‘easily available’.

The Loanable Funds Market

• Demand for loanable funds comes borrowers. The supply of loanable funds comes from savers.

• Demand for loanable funds comes borrowers. The supply of loanable funds comes from savers.

The Loanable Funds Market

• Expansionary monetary policy, by increasing bank the quantity of bank reserves, increases the supply of loanable funds, which lowers interest rates.

• Expansionary monetary policy, by increasing bank the quantity of bank reserves, increases the supply of loanable funds, which lowers interest rates.

The Impact of Monetary Policy on the Economy

• The final piece of the puzzle is that the lower interest rates increase investment, which shifts the Aggregate Demand curve to the right.– Both the level of output and the price level

increase.– Contractionary policy reduces the price level and

the level of output.– Remember that monetary policy affects Aggregate

Demand, not Aggregate Supply.

• The final piece of the puzzle is that the lower interest rates increase investment, which shifts the Aggregate Demand curve to the right.– Both the level of output and the price level

increase.– Contractionary policy reduces the price level and

the level of output.– Remember that monetary policy affects Aggregate

Demand, not Aggregate Supply.

Expansionary Monetary Policy


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Documents

Chapter 15 Parks Econ104 The Federal Reserve and Monetary Policy