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The federal reserve system
-headed by board of governors -12 federal reserve banks located throughout the nation -US monetary policy determined by the FOMC
federal reserve bank functions
-clear checks -issue new currency -withdraw damaged currency from circulation -administer and make discount loans to banks in their district -evaluate proposed mergers and applications for banks to expand their activities -collect data on local business conditions
federal reserve banks and monetary policy
-Directors "establish" the discount rate -Decide which banks can obtain discount loans -Directors select one commercial banker from each district to serve on the Federal Advisory Council which consults with the Board of Governors and provides information to help conduct monetary policy -Five of the 12 bank presidents have a vote in the Federal Open Market Committee (FOMC)
member banks
-All national banks are required to be members of the Federal Reserve System -Commercial banks chartered by states are not required but may choose to be members -Depository Institutions Deregulation and Monetary Control Act of 1980 subjected all banks to the same reserve requirements as member banks and gave all banks access to Federal Reserve facilities
special role of the federal reserve bank of NY (FRBNY)
-executes monetary policy -agent of the US Treasury conducts US gov financing operations -executes intervention in foreign market -provides custody and related services to foreign central banks -President serves as vice chair of FOMC and permanent voting member -assumed a number of roles associated with the Fed's crisis related "Credit Policies"
Board of Governors of the Federal Reserve System
-The seven-member board that supervises the banking system of the United States -appointed by president, confirmed by state -14-year non renewable term -required to come from different districts -pres selects chairman, a governor, serves as a four-year renewable term as chair
Duties of the Board of Governors
-Votes on conduct of open market operations -Sets reserve requirements -Controls the discount rate through "review and determination" process -Sets margin requirements -Sets salaries of president and officers of each Federal Reserve Bank and reviews each bank's budget -Approves bank mergers and applications for new activities -Specifies the permissible activities of bank holding companies -Supervises the activities of foreign banks operating in the U.S.
FOMC- Policy making arm the fed
-meets 8 times a year -7 members of the board of governors, president of the FRBNY, presidents of four other federal reserve banks -chariman of the board of governors is also chair of FOMC, president of FRBNY is vice chair of FOMC -issues directives to the trading desk at the FRBNY- sets Fed Funds Target
Role of Chairman
-sets agenda for FOMC meetings -supervises professional economists and advisers -volcker/greenspan/bernanke/yellen - differences in style
How independent is the Fed?
Instrument and goal independence
Independent revenue
Fed's structure is written by Congress, and is subject to change at any time.
Presidential influence: *Influence on Congress *Appoints members *Appoints chairman although terms are not concurrent
FOMC releases
-post meeting statement: afternoon of meeting -survey of economic projections: afternoon following meeting (4 times per year) -post meeting press conference following meeting wherein SEP were compiled -Minutes: 3 weeks after meeting -transcripts: 5 years after meeting
Benefits of fed transparency
-levels playing field -makes fed more accountable -reduces policy lags by cutting recognition lags to zero -improves transmission of policy via the expectations theory of yield curve -reduces "liquidity" or "term premiums" embedded in yield curve
How high fed become more transparent?
-establish an explicit inflation target -broadcast FOMC meetings on C-span -release minutes sooner -make transcripts with shorter lags -provide more frequent forecasts
why central bank independence?
-political pressure would impart an inflationary bias to monetary policy -political business cycle -could be used to facilitate treasury financing of large budget deficits - monetarizing the federal debt -too important to leave the politicians
Case against independence
-Undemocratic -Unaccountable -Difficult to coordinate fiscal and monetary policy
what determines potential gdp?
-growth of the labor force -conventions regarding work week -productivity growth = to the growth rate of labor force + growth rate of productivity
can be viewed as economy's "speed limit"
what is money?
medium of exchange, store of value, unit of account, standard of deferred payment
important characteristics of money
divisibility, portability, stability, durability, difficulty of counterfeiting, scarce
Gold Standard
-the value of currency is fixed in terms of quantity of gold -sets the money supply and price level generally with limited central bank intervention
Problems with gold standard
-money supply cannot be adjusted in response to changing economic conditions -all countries on gold standard are forced to maintain fixed exchange rates -the effects of bad policies in one country can be transmitted to other countries -if not perfectly credible, it is subject to speculative attack and ultimate collapse -didnt prevent financial panics -medium run- caused periods of inflation/deflation
the payment system
outside money - created by the gov, coins and federal reserve notes (currency) -inside money - money created in the private sector, checking accounts, travelers checks, etc
money growth rule
a rule that focuses only on the growth rate of money in the economy; under such a rule, the central bank simply would set money growth in the long run, ignoring short-run fluctuations in the economy Fire
Equation of Exchange
MV=PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is the output of goods and services produced in an economy.
Monetarists
economists who believe the velocity of money is fairly constant or predictable
Money and Price level
P=MV/Q P=MV/Real GDP
Activist rule
a rule for monetary policy under which monetary policy is allowed to change over the course of the business cycle
nonactivist rule
a rule for monetary policy under which the same monetary policy is pursued whether the economy is in a recession or an expansion (Monetarists believed in this)
Friedman's Basic Thesis
-in LR, increased monetary growth increases prices but has little or no effect on output -in SR, increases in money supply causes employment and output to increase, and decreases in money supply have the opposite effect
Keynes motives for holding money balances
Transaction motive precautionary motive speculative motive
Transaction motive
the amount of desired money balances is a function of income: the higher the income, the more money demanded for carrying out increased spending
Precautionary motive
people prefer to have liquidity incase of unexpected problems: the higher the degree of uncertainty, the greater the demand for precautionary balances
speculative motive
people retain liquidity when interest rates are low and buy bonds when interest rates are high
liquidity trap
nominal interest rate has been lowered nearly to or equal to zero to avoid recession
What is a bank?
-a place for safe keeping of money -checks can be written -channels funds to borrowers
bank assets include
-bank building & furniture etc -cash in vault -deposits at other banks (fed) -securities (treasury bills, bonds, etc) -loans
bank liabilities include
-demand deposits (checking accounts) -various savings accounts -large certificates of deposits -other borrowed monies
How do commercial banks make money?
they earn more interest on assets than they pay on liabilities
National banks
chartered by federal gov (must be members of federal reserve)
state banks
chartered by a state government, if they meet the financial standards set by the Board of Governors they may become a member bank
financial intermediaries other than commercial banks
-thrifts (saving institutions) -mutual funds -money market funds -investment banks -hedge funds -insurance companies -structured investment vehicles
steps to start a bank?
get state or national charter
inject capital to buy building, vault, and to have cash on hand
take in deposits
make loans
New York Clearing house
-member banks hold clearing balances at clearing house -"debits" or reduces the account of the payer bank -"credits" or increases the account of payee bank
Reserve requirements
depository institutions must set aside a % of their deposits as reserves to be held either as cash on hand, or as reserve account - balances at a federal reserve bank
capital requirement
bank regulators require that banks maintain adequate capital to serve as a buffer against losses
fractional reserve banking
a banking system that keeps only a fraction of funds on hand and lends out the remainder
Agents in the Money Supply Process
-federal reserve system -banks -depositors -borrowers
open market operations
-purchase increases the volume of bank reserves -sale decreases the volume of bank reserves
factors affecting bank reserves and monetary base
-float -treasury deposits at the federal reserve -interventions in the foreign exchange market -redemptions from fed's portfolio
total bank reserves = required reserves + excess reserves
required reserves = reserve ratio X deposits excess reserves =any reserves above required
Who controls deposit growth (money supply)?
-determined by a combination of the fed actions, and market dynamics
Lagged Reserve Accounting (LRA)
renders a disconnect between deposit growth and required reserve
federal funds rate targeting
if the demand for reserves increases because a bank without excess reserve wants to make a loan, the funds rate would ride, and the fed would then add the needed reserves to get the funds rate back to target
What is the Bailey Brothers Building & Loan (BBB&L) to do?
-choice 1: call in loans -choice 2: sell assets -choice 3: try to borrow money -choice 4: jump off bridge to collect on life insurance policy
federal funds market
A market for overnight lending and borrowing of reserves among banks; the market for reserves on account at the FED
The Fed Controls the Supply of Bank Reserves
-federal reserve determines the supply of bank reserves -by buying/selling securities. buying = securities shifts supply curve to the right. selling = securities shifts supply curve to the left
What determines demand for bank reserves?
-required reserves= the mandated required reserves ratio X reservable deposit liabilities -excess reserves = all reserves beyond that required to meet mandated required reserves.
excess reserves demand
-determines levels of funds rate -influences by degree of uncertainty. onset of credit crisis uncertainty rose, so did the demand for excess reserves. -increase in uncertainty shifts the demand for reserves outward, and unless the supply is increase will cause the funds rate to rise.
dynamic open market operations
aimed at fundamentally changing the funds rate target - Policy Decision
defensive open market operations
aimed at offsetting changes in the autonomous reserve factors (those that add or drain reserves) with an intent of getting the funds rate to trade close to target
money market instruments
-federal funds -large negotiable certificates of deposit -eurodollars repurchase agreements and reserves RPs -treasury bills -commercial paper
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Flashcard (94)