Transcript No Slide Title

Current Events
The FOMC meeting
This is material we will cover later in the
course, but given the significance of what is
going to happen today, it seems reasonable to
cover this. This material will not be on Exam
#1.
I The Current Economic Situation
A) Over the past year, the Federal Reserve
Bank has been raising its interest rates to
attempt to slow the economy down from
the very rapid growth it was experiencing.
B) These policies were successful in slowing
the economy down. However, they were
probably too successful, because now we
find ourselves on the verge of a recession.
II Basics concepts
A) The Federal Reserve Bank is the U.S.
central bank.
1) Contrary to its name, it is not technically
part of the Federal Government, but has a
great deal of independence. This
independence is given to them so that they
do not carry out policies which may
influence political elections.
2) The Federal Reserve Bank consists of a
main office in Washington called the Board
of Governors and 12 district banks located
throughout the country. This structure is an
effort to diffuse power.
B) The Federal Open Market Committee
(FOMC) is the policy making body which
meets ever 6 weeks and happens to be
meeting today.
1) It consists of 12 people. Seven are the
Board of Governors based in Washington
and the other 5 are district bank presidents
who serve on a rotating basis.
2) The seven Board of Governors are fourteen
year terms and are nominated by the
president and confirmed by Congress.
Since their terms expire in odd years, any
given president can only appoint a few
members of the board.
3) The district presidents are chosen by the
district banks which own stock in the bank.
4) The New York Federal Reserve Bank
President is always on the FOMC and has a
special role.
C) Basics on Banking
1) When someone deposits money in a bank,
the bank does not simply hold it until the
depositor comes back to withdraw it.
Instead they loan it out. That is how they
make a profit.
2) Because banks make a profit by issuing
loans they prefer to loan everything they
have. However, rules set up by the central
bank prohibit them from loaning all of the
deposit. Instead they must keep part of
the deposit on hand. This amount is called
the reserve.
3) Money consists of anything that can be
used for transactions purposes. Thus, the
loans created by banks are a type of money.
In fact 90% of the money supply is created
by the commercial banking system while
only 10% is created by the Federal Reserve
Bank.
4) Since banks make their profits by issuing
loans, they go right up to their reserve
requirements. If they fall below the reserve
requirement on any day, banking regulations
require that they borrow money overnight.
5) Banks have two places to borrow
overnight: The Federal Funds Market at
the Federal Funds Rate, and directly from
the Federal Reserve Bank at the Discount
Rate.
D) The Federal Funds Market
1) The Federal Funds Market consists of
demanders who are banks who have fallen
below their reserve requirements and
suppliers who are banks who are above
the reserve requirements.
2) The market clearing interest rate in the
Federal Funds market is called the Federal
Funds rate.
3) When the Federal Funds rate is high, then
it is more costly for banks to fall below
their reserve requirements and they make
decide not to grant as many loans. In
other words, a high federal funds rate
means that credit is tight. This usually
means that there is less investment going
on in the economy.
4) When the FOMC meets, they announce two
things: A Federal Funds Rate target and a
Discount Rate value.
5) They reach the Federal Funds target by
using Open Market Operations where they
buy and sell bonds in the open market. This
is carried out by the President of the New
York Federal Reserve Bank, hence this is
why he is a permanent member of the
FOMC.
6) If the Fed wants to reduce the Federal
Funds target they will expand the money
supply in the overnight loan market by
buying bonds in the open market. Note,
they cannot precisely control the Federal
Funds rate.
7) This will encourage banks to make
additional loans and thus stimulate the
economy.
E) The Discount Rate
1) The FOMC also controls the discount rate
which is the second way that banks can
satisfy their reserve requirements.
2) Typically the Discount Rate is ¼ to ½ of a
percent below the Federal Funds Rate
target.
3) Banks rarely borrow directly from the Fed
instead preferring to borrow anonymously
in the Federal Funds market.
III What do we expect today.
1) The Fed will make its announcement at
2:15 eastern time, 1:15 local time.
2) Most expect an aggressive move of 50
basis points in both key rates
3) If there is only a 25 basis point move,
expect a dramatic decline in stocks later
this afternoon.
4) If there is a 50 basis point move, stocks
should move higher.
5) If there is a 75 basis point move, stocks are
likely to move significantly to the upside.