Transcript Why study Money & Banking?

Chapter 18. Monetary Policy
• The market for reserves
• Open market operations
• Discount lending
• Reserve requirements
• Goals of monetary policy
• Using targets
The Market for Reserves
• interbank lending market
•
 federal funds rate (FF rate)
FOMC impacts this market
 which impacts other debt markets
& economy
The Fed and the FF rate
• open market operations
•
•
 shift the supply of reserves
discount loans
 setting discount rate affects bank
borrowing and supply of reserves
reserve requirement
 affects demand for reserves
Open Market Operations (OMO)
• buying & selling Treasuries
•
•
 large & liquid market
open market purchase
 increase supply of reserves
 decrease FF rate
OMO are the Fed’s main policy tool
• FOMC votes on OMO
•
 votes on FF rate target
FR actually buys and sells
Treasuries
 to achieve the FF rate target
advantages of OMO
•
•
•
•
Fed has complete control
OMO are flexible
 buy/sell a little or a lot
OMO are easily reversible
 sell too much? then buy some back
OMO quickly impact reserves, FF rate
Discount Lending
• each c bank has a discount window
•
 set discount rate
 set discount policy
lower discount rate
 increase borrowing, reserves
 decrease FF rate
• why do banks get discount loans?
•
 short-term liquidity problem
 serious problems
 seasonal reserve fluctuations
 but should not ask for help too
often
discount rate is 50-100 bp. ABOVE
the FF rate
Discount loans & monetary policy
• discount loans not a good tool
• not completely under Fed control
•
•
 banks decide to borrow
can give misleading signals
 if done for non-policy reasons
not easily reversible
 cannot change rates on old loans
Reserve requirement
• set by the Board of Governors
• higher requirement
•
 increase demand for reserves
 increase FF rate
today (since 1992)
 3% on checking up to $44.3 million
 10% above $44.3 million
• reserve requirement is very powerful
tool
 too powerful
 not good for small adjustments
 expensive to change
Goals of Monetary policy
• desirable goals for the economy
• Fed uses monetary policy to achieve
these goals
 directly control tools,
to influence goals
High employment
• i.e., low unemployment
• federal government has a
•
commitment to full employment
goal: natural rate of unemployment
 about 4-5%
 today: 4.7%
Economic Growth
• annual % change in real GDP
• U.S. long run average -- 3%
• 2006 real GDP growth 1.5%
Price stability
• i.e., low inflation
•
•
•
 annual % change in CPI
primary goal of Fed since 1980s
how high is too high?
 over 4%
 goal: 2% or less
Oct 2007: about 3.5%
Financial Market Stability
• stability of financial institutions
• stability of interest rates
• stability of exchange rates
• Fed stabilized markets
 October 1987
 Summer 1998
 September 2001
Using targets
• Fed directly controls tools (like
•
OMO), not goals
it can take a year for tools to impact
the goals
 how to measure progress in
between?
Targets
• related to tools and goals
• used by Fed to judge if they are on
track
tool
(OMO)
operating
instrument
intermediate
target
goal
operating instrument
• respond immediately to changes in
•
the tools
examples
 bank reserves
 FF rate
 Tbill rate
intermediate targets
• affected by operating target
• closely associated with goals
• examples
 M1or M2
 Tnote yields
effective instruments
• observable by everyone
• controllable and quickly changeable
•
by the Fed
predictably related to goals
2 types of targets/instruments
• monetary targets
•
 reserves, MB
 M1 or M2
interest rate targets
 FF rate
 other short or medium-term rates
target tradeoff
• Fed can target money supply OR
•
•
interest rates
NOT BOTH!
why?
• suppose Fed targets M* for MS:
i
MS
i’’
MD’’
M
M*
• but as MD fluctuates, i will change:
i
MS
i’’’
i’’
MD’’’
i’
MD’’
MD’
M
M*
• so if target M*, lose control of i
i
MS
i’’’
i’’
MD’’’
i’
MD’’
MD’
M
M*
• suppose Fed targets i*
i
MS
i*
MD’’
M’’
M
• but as MD fluctuates, Fed must shift
MS to maintain i*
i
MS’
MS
i*
MS’’’
MD’’’
MD’’
M’
M’’
MD’
M’’’ M
• Fed targets i*, lose control of M
i
MS’
MS
i*
MS’’’
MD’’’
MD’’
M’
M’’
MD’
M’’’ M
Targets
• If Fed targets MS, loses control of
•
interest rates
If Fed targets interest rates, loses
control of MS
The Taylor Rule
• How to choose the FF rate target?
• Base target on
 Current inflation
 Target inflation
 Current real GDP
 Potential real GDP
• FF rate target =
•
2.5 + current inflation
+ (1/2)(current-target inflation)
+ (1/2)(current - potential GDP)
A guideline for the Fed