Transcript the federal reserve and monetary policy

THE FEDERAL RESERVE AND
MONETARY POLICY
https://www.youtube.com/watch?v=1
dq7mMort9o
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I. THE FEDERAL RESERVE SYSTEM
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A. Overview
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1. US lacked a national bank in early 1900s
2. runs on the banks were common
3. Govt. passed Federal Reserve Act of 1913
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B. Roles of the Fed
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1. Conduct the nation’s monetary policy
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Dual mandate-price stability and maximum employment
2. Supervise and regulate banks
– Banks are rated on CAMELS
» Capital
» Asset quality
» Management
» Earnings
» Liquidity
» Sensitivity
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3. Maintain stability of the financial system
4. provide financial services to banks, US
government, and foreign institutions
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C. Organization of the Fed
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1. Board of Governors (Federal Reserve Board)
» a. President appoints 7 members, Sen. confirms
» b. 14 year terms
» c. Chairman and vice chairman serve 4 year terms
» d. Issues policies to regulate money supply
» e. Chair testifies before Congress
» f. Oversee Reserve Banks, approve appointments
of their presidents and 3 of their board of directors
» g. Participate on the FOMC
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2. Federal Open Market Committee (FOMC)
» a. chief body for monetary policy
» b. Made up of 12 members: 7 board of governors,
pres. of New York’s bank; 4 others are district bank
presidents on 1 year rotating terms
» c. Discuss economic outlook and forecasts,
developments in financial markets
» d. Vote on monetary policy
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3. Federal Reserve Banks (12) across country
» a. serve as banker’s bank distributing currency,
making loans, processing electronic transactions
» b. Help govt by holding accounts for Treasury
dept, process govt checks, conduct bond sales
» c. Conduct research on economy
» d. Are set up like private corporations; member
banks have stock in them and earn dividends and
get to appoint 6 out of 9 of the board of directors
» e. supervise banks in their district and help Fed
carry out objectives in that area
https://www.youtube.com/watch
?v=RaeIBeJT5hY
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II. MONETARY POLICY STRATEGIES
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A. Affect on Aggregate Demand
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1. Monetary policy-expanding or contracting the
money supply to influence the cost and
availability of credit
2. Easy/Expansionary Money-designed to
increase money supply, increase demand,
create jobs
3. Tight/Contractionary Money-designed to
contract the money supply, decrease demand,
halt inflation
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B. Components of Monetary Policy
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1. Open-Market Operations
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a. buying and selling of govt. securities by the Fed
b. most used monetary policy tool
c. federal funds rate-interest rate at which banks
borrow from each other: Fed Reserve sets a target for
this and uses OMO to reach it
» i. Lowering it makes borrowing easier and
increases the money supply
» ii. Raising it makes borrowing more difficult to
borrow and decreases the money supply
d. Fed buys securities to expand (ease) the money
supply; sells govt. securities to contract (tighten) the
money supply
EXPANSIONARY (easy money)
POLICY
Fed buys govt
bonds
depositing
money in the
banks
Bank reserves
for lending
increase
Banks decrease
interest rates to
attract borrowers
CONTRACTIONARY (tight money)
POLICY
Fed sells govt
bonds taking
money from
the banks
Bank reserves
for lending
decrease
Interest rates
go up
because
there is less
money to
lend
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2. Discount Rate
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a. the interest rate the Fed charges member banks
b. Fed acts as lender of last resort
c. lowering makes it easier for banks to borrow and increases
the money supply; raising it contracts the money supply
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3. Reserve Requirement
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a. money that must be held by banks either in their own vaults
or in their accounts at the district Fed bank
b. if it’s low, banks can loan more money out and expand the
money supply; it it’s high, banks have to hold more so the
money supply contracts
c. rarely changed
Reserve Requirements
Requirement
Liability Type
% of liabilities
Effective
date
$0 to $11.5 million2
0
12-29-11
More than $11.5 million to $71.0 million3
3
12-29-11
More than $71.0 million
10
12-29-11
Net transaction accounts 1
• D. how banks create money
– 1. money multiplier = 1/reserve requirement
» If the reserve requirement is 10% (.1) divide 1/.1=10
» A $1 deposit in the bank can create $10 of new
lending
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Example
$100 deposited, $10 set aside, $90 loaned out
$90 deposited, $9 set aside, $81 loaned out
$81 deposited, $8.10 set aside, $72.90 loaned out
$72.90 deposited, $7.29 set aside, $65.61 loaned out
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E. Limitations of Monetary Policy
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1. Economic forecasts
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2. Time Lags
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a. must balance inflation and unemployment
4. Lack of Coordination
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a. takes a long time to study data
b. takes a long time to make decisions on what to do
c. takes time for policies to cause desired effect
3. Priorities/Trade-Offs
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a. don’t know if they’ll be accurate or not
a. with fiscal policy
5. Conflicting Opinions
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a. people disagree on how money supply should be
regulated
Federal Reserve/Monetary
Policy Review
Mark E for easy money and T for tight money
strategy by the Federal Reserve
• 1. The Fed raises the federal funds rate.
• 2. The Fed lowers the reserve requirement.
• 3. The Fed conducts an open-market operation
by purchasing govt. securities from banks.
• 4. The Fed lowers the discount rate.
• 5. The Fed conducts an open-market operation
by selling govt. securities to banks.
• 6. The Fed raises the discount rate.
• 7. If the economy is experiencing inflation,
should the Fed use an easy money or tight
money policy?
• 8. If the economy is experiencing high
levels of unemployment and recession,
should the Fed use an easy money or tight
money policy?