453 - reading notes

Question 1

structure of fed reserve system

Answer 1

1913 established Fed

• -composed of 3 branches
  1. 12 regional fed. reserve banks throughout US
  2. ccentral gov. agency called board of governors of Fed (in DC)
  3. Fed open market committee (FMOC)

all national banks are chartered by the fed - req. to belong to fed system
–reserve banks - chartered banks, private nonprtofit organizations. - owned by commercial banks in their districts

9 members of board of governors

• -6 elected by commercial bank members of reserve bank and other 3 are appointed by board of governors
• -each reserve bank has a president - responsibility to oversee FOMC - 5 year term

Question 2

brief list of bank’s functions

Answer 2

1. Banks of US gov.
   - —Issue new currency (Fed reserve notes) and destroy old worn currency
   - —Maintain US treasury bank account and process electronic payments
   - –Manage US treasury’s borrowings - issuing, transferring and redeeming US treasury bonds, bills and notes
2. As bankers’ bank
   - —Hold deposits for banks in their districts
   - –Operate and ensure the integrity of pts. Network for transferring funds
   - —Make funds available to commercial banks within the district through DISCOUNT LOANS on which they charge at the DISCOUNT RATE
   - — Supervise and regulate fin. Institutions in district to ensure safety and soundness - evaluate mergers and operations
   - –Collect and make available data on business conditions
3. Fed of NYC
   - –Provides services to foreign central banks and international organizations hold accounts there
   - —Is system point of contact with fin. Markets
   - –Where treasury securities are auctioned, where foreign currency is bought and sold, and where Fed Reserve’s own portfolio is managed through OPEN MKT. OPERATIONS
4. Formulate monetary policy
   - –Do it through representation on federal open mkt. committee (FOMC) - makes int. rate decisions and determines size of fed’s balance sheet - through setting the DISCOUNT RATE (rate charged on loans to commercial banks)

Question 3

the board of governors

Answer 3

HQ in DC - close to white house

• -7 members of board are governors, appointed by president and confirmed by senate to serve 14 year terms
• -terms are staggered with one beg. every 2 years
• -no 2 gov. can come from same district

DUTIES

	1. Set reserve requirement - determines level of reserves banks are req. to hold
	2. Approves/disapproves discount rate recommendations by fed reserve banks
	3. Approves changes in int. rate paid on excess reserves consistent with changes in the rate for target fed. funds rate set by FOMC
	4. Acts as rule-writing agency for consumer credit protection laws
	5. Approves bank merger applications
	6. Supervises and regulates reserve banks (budgets and salaries)
	7. Along with Fed banks, supervises banking system - examining indiv. Banks, SIFIs, and fin. Mkt. utilities (FMUs) for safety and soundness and compliance with law
	8. Invokes EMERGENCY POWERS to lend to nonbanks when circumstances are unusual and exigent - provided authority during crisis
	9. Analyzes fin. And economic conditions (domestic and international)
	10. Collects and publishes detailed stats about system's activities and economy at large (FRED - fed. Reserve economic database) - info. About US and other economies

Question 4

FOMC

Answer 4

group that sets interest rates and adjusts Fed’s balance sheet to control availability of money and credit to economy

1936 - 12 voting members - 7 governors and Pres. of Fed of NYC and rotating selection of 4 of remaining 11 reserve bank presidents

FOMC controls the FED. FUNDS RATE

• –controls nominal int. rate - controls real int. rate acually bc inflation expectations don’t change qucikly when credible bank aims at price stability
• —higher int rate = inc. cost of borrowing = ess likely to invest in projects for growth and expansions

meet 8 times a year for 6 weeks in DC

2 imp. documents from meetings

1. BEIGE BOOK - compilation of anecdotal info. about current business activity - published 2 weeks before meeting and info. colected by stage
   - –only Fed doc. released to public before meeting
2. TEALBOOK - 2 parts: board staff’s economic forecast for next 2 years (used to be called green book til 2010)
   - –and discussion of fin. mkts. and current policy options (used to be called bluebook)
   - -distributed electronically during week before meeting

Question 5

Fed’s reserve system structure

Answer 5

Effective central bank is one where policy makers are largely independent of political influence, make decisions by committee, are accountable and transparent, and state objectives clearly

1. Independence of political influence
   - —-Budget independence, irreversible decisions, long terms in office
   - —Fed’s rev. from int. on gov. securities and fees it charges banks for pmt. System services
   - -FOMC controlled by board of gov. and ECB controlled by NCBs
2. Decision by a committee
   - –FOMC is committee - chair of board of Governors dominates policy decisions but there are 12 voting members - no one person can be dictator
3. Accountability and transparency
   - — FOMC releases huge amts. Of public info. - beige book prior to meeting and after meeting releases posts on website of brief policy stmt. Of decisions and reasons
4. Policy framework
   - –Inflation targeting framework - utilized by most leading banks around the world - established by FOMC in 2012 on special stmt. Of longer-run goals and monetary policy strategy
   - -FOMC has the dual mandate of price stability and full employment - make decisions with those tradeoffs
   - -Governing council has pricate stability as the main goal - all others are secondary

Question 6

European central bank

Answer 6

1992 agreement to form Euro. monetary union formalized in treay of Maastricht
–led to creating of Euro. system of central banks (ESCB) —> the euro. central bank (ECB) in Frankfurt Germany and national central banks in 28 countries

6. member executive board of ECB (like board of gov.)
   - -also governing council (like FOMC - who formulates monetary policy)

ECBs activity is control of money and credit in the Eurosystem

Question 7

Chair of board of governors

Answer 7

most powerful person in Fed - also chair of FOMC - effectively controls FOMC meetings and monetary policy
–appointed by President to 4 year term

Question 8

which federal reserve regional bank serves in Utah?

and which of regional banks in Fed system is point of contact with fin. markets

chair of board of gov. of Fed serves ___ year erm and may be reappointed to more than one term

Answer 8

SF

NY

4 year

Question 9

the board of governers

FOMC controls ___

most imp. member of FOMC is

in ESCB what is most similar to FOMC

Answer 9

1. sets the reserve requirement
2. approves/disapproves of discount rate recommendations
3. invokes emergency powers to lend to nonbanks when circumstances are deemed “unusual and exigent”

FOMC controls fed funds rate

most imp. is the chair of board of gov. of fed

in Euro - FOMC similar to governing council

Question 10

which of following are goals that Congress established for Fed?

Answer 10

all of the above!!

• -max employment
• -stable prices
• -moderate LT int. rates

Question 11

primary objective of Euro. system of central banks is to

Answer 11

maintain price stability

Question 12

9/11 info.

Answer 12

2 in twin towers, one in Pentagon in DC, and one in field in Pennsylvania

• —On brink of collapse, but bc of quick moving Fed, the financial system held together
• –3 hours after crisis - the Fed announced they would be able to provide liquidity as needed - stop the spreading of panic and made sure there was enough money circulating in economy
• –Bought almost $100B worth in US treasuries - extended 10s of 1000s of loans
• —All done in backup sites - bc the main financial federal reserve bank was in NYC right by the side of the fallen towers

The financial system was one of the terrorists primary targets…bc of quick action of the Fed, it returned to normal in a couple weeks
During crisis of 2008-09
—Fed lent money to nonbanks and nonfinancial institutions for the first time
—They failed to recognize how their actions affected the supply of credit in economy - how changes in Fed balance sheet affected the growth rate of money
—Thought that if they supplied more and more money in economy, credit and money would be easily available - wrong bc the fin. System collapsed - bc Fed had failed to provide liquidity that sound banks needed to stay in business - so no one could borrow and amt. of credit and money circulating fell dramatically

Question 13

central bank’s balance sheet

Answer 13

Many transactions bc it is the government’s banker and the bankers’ banker
—-Supplies currency, provides deposit accounts to gov. and commercial banks, makes loans, buys and sells securities and foreign currency –> all cause CHANGES IN FED’S BALANCE SHEET

BS published weekly

ASSETS

• –gov. banks = securities, foreign exchange reserves
• -bankers bank = loans

LIABILITIES

• -Gov. bank - currency, gov. account
• –Bankers bank - accounts of commercial banks (reserves)

during crisis -commercial bank deposits grew 100x!!!! triggered by Lehman bro. panic - Fed sought to calm banks desperately seeking liquiity by buying securities and boosting discount lending
–after crisis - banks began holding excess reserves in Fed

Question 14

Assets of fed - securities

Answer 14

Three basic assets - securities, reserves and loans

1. Securities - primary assets of most banks
   - —Used to be exclusively treasuries (short maturity)
   - —During crisis 08/09, fed took on riskier assets (including $1 T of MBS - look at pg. 53 - MBS became largest component of fed’s assets
   - –Then started buying medium—> LT securities - put US more in debt
   - —Quantity of securities controlled by OPEN MARKET OPERATIONS - independent central banks determine the quantity (not the fiscal authorities)

before crisis, Fed controlled fed funds rate by adjusting holdings of liquid securities (US ST Treasuries)

Question 15

Assets of fed - foreign exchange reserves

Answer 15

2. foreign exchange reserves
   - —Central bank and gov.’s foreign currency - held in form of bonds issued by foreign gov.
   - –Euro dominated bonds issued by German gov. and Yen bonds issued by Jap. Gov.
   - —Reserves used in foreign exchange interventions - when officials attempt to change market values of various currencies

Question 16

Assets of fed - loans

Answer 16

loans

• —Usually extended to commercial banks - but during crisis, Fed made loans to nonbanks to
• –Discount loans - loans that Fed makes when commercial banks need short-term cash

Question 17

LIABILITIES - currency

Answer 17

• –Almost all central banks have monopoly on issuance of currency in everyday transactions
• –All bills have “federal reserve note”
• –Currency in the hands of “nonbank public” is the largest liability of most central banks

Question 18

LIABILITIES - gov. account

Answer 18

—Place for gov. to deposit income (mostly tax revenue) and where they write checks and make electronic pmts. - acct. balance usually pretty constant

Question 19

LIABILITIES - commercial bank account (Reserves)

Answer 19

§ Sum of 2 parts: deposits at central bank PLUS the cash in the bank’s own vault
1. Acts like the commercial bank’s checking account - can withdraw deposits at central bank - and can transfer funds to another bank’s account
® Vault cash - part of reserves - available to meet depositors’ withdrawal demands - serves as the insurance function for which reserves are designed
® Reserves are assets of commercial banking system and liabilities of the central bank
® Reserves are the LARGEST liability of the Fed and ECB as of 2016

msot imp. liability in central bank is reserves - determines amt. of money and credit in economy - plays central role in policy
—inc. lead to deposits and growth in availabilty of money - dec. is opposite

2 types of reserves

1. req. reserves
2. excess reserves

Question 20

monetary base

Answer 20

Currency in hands of public and reserves in banking system (liabilities of central bank) make up the monetary base - or called high-powered money (high powered bc is a multiple of currency plus banking system reserves)

• —Bc when the monetary base increases by $1, the quantity of money usually rises by several dollars
• –Central bank controls the size of monetary base

Question 21

changing size and composition of BS

Answer 21

Central bank controls the size of their balance sheet - policymakers enlarge or reduce assets and liabilities

• —Ex. When we spend $50 at grocery store, goes through pmt. System and the $50 is credited to the supermarket’s account and debited in our account (becomes $50 smaller)
• —But FED is diff. - Fed spends $1M on bonds - to pay for it, the central bank writes a check of $1M payable to the bond dealer who sells the bond - after check is deposited, the dealer’s commercial bank is credited $1M and commercial bank sends the check back to the central bank - this time the Fed credits the $1M reserve in the account of the bank presenting it
• —The central bank buys the $1M bond, then creates liabilities to pay for them (the $1M inc. in reserves in the banking system) - can inc. balance sheet when it wants to

Question 22

4 types of transactions to do this - all affect SIZE of BS and CHANGE size of monetary base

Answer 22

Cash withdrawals by the public are diff. - shift components of monetary base bc change composition of balance sheet but do not change the size
—Remember that when value for an asset increases, another asset dec. by same value to make net change of 0 or a liability grows by same amt.

open mkt. operations, foreign exchange intervention, extension of a discount loan, decision of indiv. to withdraw cash from bank

Question 23

4 types of transactions to do this - all affect SIZE of BS - open market operations

Answer 23

1. Open market operations - Fed buys/sells a security in fin. Mkts.
   —-Have a straight impact on Fed’s balance sheet
   ○ Common case - NYC Fed buys $1B in US treasury bonds from commercial bank - to pay for bonds, Fed transfers $1B into reserve account of the seller - exchange done electronically

Go back to 459 to look at balance sheet picture

• —Federal reserve’s balance sheet
• —Assets: securities inc. by $1B
• —Liabilities: reserves inc. by $1B
• —Banking system’s balance sheet - fed exchanged $1B in securities for $1B in reserves…both are assets to commercial banks
• —-Assets: so reserves go up by $1B, and securities down by $1B (no changes on liabilities)
• —Easy to remember if think of your own bank acct. - the balance on Wells Fargo is an asset to me but a liability to the bank

If Fed sells a US treasury bond it is called an OPEN MKT. SALE - impact on balance sheet is reversed - Fed’s balance sheet shrinks bc both sides fall by $1B and monetary base falls - on the banking system BS, the securities INC. and the reserves DEC.

Question 24

4 types of transactions to do this - all affect SIZE of BS - foreign exchange intervention

Answer 24

buys/sells foreign currency

• –Buy $1B of Euros - Fed NYC buys German gov. bonds fro foreign exchange department of large commercial banks and pays with dollars
• —-Fed’s balance sheet (growing balance sheet and expanding monetary base)
• —Assets: foreign exchange reserves up by $1B
• —Liabilities: reserves up by $1B
• —Banking system balance sheet (bc Fed bought from a commercial bank)
• —-Assets: reserves up by $1B, securities down by $1B (net 0, no liability change)

Question 25

4 types of transactions to do this - all affect SIZE of BS - extension of a discount loan

Answer 25

to commercial bank by central bank

• —Does not force commercial banks to borrow money, the banks ask for loans - to get one, borrowing bank has to provide collateral (usually in form of US treasury bonds, but Fed also willing to accept broad range of securities and loans as collateral)
• —When Fed makes a loan, changes balance sheet on both sides
• –Inc. loans is an asset to the Fed and change in reserves inc. its liabilities - in this case both Fed and banks expand their balance sheet as both sides increase
• —Federal reserve’s balance sheet
• ——Assets: discount loans up by $100M
• ——-Liabilities: reserves up by $100M
• —–Banking system’s balance sheet
• ——Assets: reserves up by $100M
• —–Liabilities: discount loans up by $100M

Question 26

4 types of transactions to do this - all affect SIZE of BS - Decision of indiv. to withdraw cash from bank

Answer 26

4. Decision of indiv. To withdraw cash from the bank
   - — Fed can always change its amt. of assets - can buy/sell US treasuries, buy foreign bonds, make discount loans…but cannot control its liabilities
   - — Bc the Fed stands ready to exchange reserves for currency on demand, so does not control how quickly banks will make withdrawals and change their liabilities - the people who hold the cash control the size of liabilities
   - —-Shows that when we take cash out of an ATM, we are changing the Fed’s balance sheet size
   - —Reason is that VAULT CASH is part of reserves, while currency holdings of nonbank public are not (our cash)
   - —So when we move our assets out of the bank and into currency we force a shift from reserves to currency on Fed’s balance sheet

Ex. Withdraw $100 out of ATM from checking acct. - transaction changes composition of asset side of YOUR balance sheet

• –By taking $100 out, had impact on bank’s balance sheet, bc cash inside bank…vault cash…is a reserve, so as we withdraw cash from bank we dec. banking system’s reserves
• —This shrinks our bank’s balance sheet - change in assets = change in liabilities (Dec. bc owe you less money on demand)
• —Then the Fed controls size of its balance sheet, so transactions don’t impact that…but when we withdraw we change the composition of balance sheet
• —By withdrawing cash, we changed amt. of currency oustanding

Question 27

Deposit expansion multiplier

Answer 27

central banks liabilities form the base on which supplies of Money and credit are built - called monetary base
–controlled by fed who expands or contracts base

how do reserves become bank deposits? - banking system makes them in process called deposit creation

ex. open mkt. purchase where fed buys $100,000 from first bank
- –Fed’s purchase leaves total assets of first banks BS unchanged, but shifts $100,000 in securities into reserves
- -moves money from purchase into reserve balance (which is excess reserves) - need to be profitable with funds they rec. bc fed pays low int. on reserves
- -then OBI borrowes $100,000 on a loan from first bank
- –so change is -$100,000 in reserves and add $100,000 in loans on asset side
- -checkable deposits is liability so -$100,000 but htey pay it immediately so actually net effect of 0

Question 28

only the fed

Answer 28

can create or destroy the monetary base!!

Question 29

deposit expansion multiplier

Answer 29

the inc. in commercial bank deposits following a one-dollar open market purchase
–if assume they hold no excess reserves and no change in currency held by nonbank public…then level of reserves is req. reserve ratio * deposits = the level of reserves

for every $1 inc. in reserves, deposits inc. by 1/rd

• -rd = req. reserve ratio
• -if reserve req. is 10% - then simple deposit epansion multiplier= 1/.1 = 10
• -meaning a $100,000 open market purchase would generate $1,000,000 inc. in Q of money
• -dec. as goes to banks bc they keep 10% of it as reserves

dec. in reserves also generaes a deposit contraction - which dec. base
- -$100,000 open market sale - fed sells security in exchange for reserves - reuce deposits

Question 30

deposit expansion with excess reserves and cash withdrawals

Answer 30

reserve req. = 10%, bank wants to hold excess reserves of 5% of checking account deposits and holder of checking account withdraws 5% of deposit in cash

1. fed purchases $100,000 worth of securities from first bank - who made a loan of $100,000 to OBI who used $100,000 to buby steel - which took funds from first bank and put in second bank
   - -if Am. steel takes some of cash and second bank wishes to hold excess reserves…then next loan cannot be $90,000 like prev. ex.
   - –so Am steel took 5% of funds which leaves $95,000 in checking account - then of $95,000 of that in second bank…10% in req. reserves and 5% in excess reserves - whcih takes out $14.250 of loan and leaves $80.750

now multiplier is more complicated – formulas below

Question 31

quantity of money formual

money formula

monetary base

reserves

Answer 31

this is all helping us understand relatinoship btwn deposits and reserves

M = m * MB
---Q = monetary base # money multiplier

money =. currency + checkable deposits

monetary base = currency + reserves

reserves = req. reserves + excess reserves

Question 32

Excess reserve to deposit ratio

Answer 32

R =. RR + ER
excess reserve to deposit ratio = (ER/D)

—amt. of excess reserves a bank holds depends on the costs and benefits of holding them

Question 33

currency to deposit ratio

Answer 33

C = (C/D)*D

decision of. how much currency to hold depends on costs and benefits

• -cost is int. would earn on deposit and benefit is lower risk and greater liquidity
• -int. rates inc. cash is less desirable

Question 34

now realize about Q M formula

Answer 34

monetary base has three uses = req. reserves, excess reserves, and cash in hands of public

simple formula

Q = MB * MM

now know
Q = ((C/D) + 1 / (C/D + rD + ER/D)). * MB

• –rD = req. reserve ratio
• –C/D = currency to deposit ratio
• —ER/D = excess reserve to deposit ratio

shows Q of money in economy depends on 4 variables

1. monetary base - controlled by central bank
2. reserve req. - imposed by reglulators on banks
3. desire of banks to hold excess reserves
4. demand for currency by nonbank public

Question 35

4 factors and their impact on Quantity of money

Answer 35

1. monetary base
   - -controlled by Fed
   - -if INC
   - -Q money wil INC
2. req. reserve ratio
   - -controled by Fed
   - –if INC
   - –Q money will dec. (bc both in denominator so see that if inc. then the MM decreases - same with #3)
3. excess reserve to edposit ratio
   - —controlled by Commercial banks
   - –if INC
   - -Q money will dec.
4. currency to deposit ratio
   - -controlled by nonbank public
   - -if INC
   - -Q of money will dec.

Question 36

which is asset on balance sheet of fed?

• -currency, deposits of US gov. at Fed
• -loans issued to banks by Fed
• -deposits of commercial banks at Fed

Answer 36

loans issued to banks by Fed

Question 37

When the Federal Reserve buys $1 million worth of Treasury bills from a US commercial bank through its open market operations

Answer 37

The reserves portion of its liabilities increases by $1 million

Question 38

____ loans are loans by Fed when banks need ST cash

Answer 38

discount

Question 39

Assume that a financial crisis leads to the following: banks decide to hold higher excess reserves and the non-banking public decides to carry more cash in their wallets and homes. Which of the following would result?

Answer 39

1. C/D ratio would inc.
2. excess reserves to deposit ratio would inc
3. money multiplier would inc.

ONLY 1 AND 2

Question 40

Since the Federal Reserve can only control two of the four variables that determine the money supply, it no longer targets the money supply as policy tool. Instead, for short-run policy, ________________ have become the monetary policy tool of choice for the Federal Reserve

Answer 40

—interest rates

Question 41

interest rates

Answer 41

Cost of borrowing and reward for lending

• —High rates restrict growth of credit, which makes it harder for businesses to get financing and for indiv. To find or keep jobs
• —The Federal Open Market Committee sets the policy and changes targets
• —During 2007/08 - FOMC lowered target fed. Funds rate 10x!! From 5.25% to a range of 0- .25% …first time in history nominal fed. Funds rate hit zero!!!

Zero lower bound (ZLB) - term for nominal int. rates used bc of the belief that commercial banks could always hold cash in replace of reserves…so central banks could not reduce policy rates below zero
—-Bc of transaction costs of holding cash (storage, transportation, insurance) - it is possible to lower rates below zero…but there is an effective lower bound (ELB) - where intermediaries and customers will switch to holding cash

uring crisis - GDP fell 4% lower in 2009 than 2008 - hit bottom spring 2009, largest drop in more than 60 years (GD)
○ Unemployment rate jumped from 4.4% to 10%%
○ But even setting Fed. Rate to zero couldn’t stabilize - so low that major fin. Intermediaries did not have incentive to lend = to those of interbank loans, commercial paper, home mortgages
§ Led to companies who had always been able to borrow short term to pay employees, purchase materials couldn’t find financing
○ Led to the Fed’s balance sheet EXPLODING - in order to lend to several companies in large amounts - new programs to fund key fin. Mkts. By directly/indirectly purchasing fin. Instruments

Question 42

target fed funds rate

Answer 42

Int. rate banks make overnight loans to each other - uncollateralized loans to banks

• —Announced by the FOMC as the target range for the mkt. fed. Funds rate
• –Influences int. rates throughout the economy
• —Before the crisis, target fed. Funds rate was FOMC’s primary policy instrument - meetings always focused on setting the target rate
• —The rate is determined by the market, not the Fed - rate banks borrow from each other overnight - so the TARGET Rate is set by FOMC, and the actual MKT. FED. FUNDS RATE is determined by markets
• —“Fed. Funds” is bc it is funds are reserve balances held by banks at Fed. Reserve banks
• —Banks borrow bc some have excess and some need to meet the requirement on reserves - before crisis, very few excess reserves

Demand for reserves is negatively related to the cost of holding them

• —–Alternative to holding reserves is loaning to another bank overnight…so the fed. Funds rate is the best estimate of OPP COST of holding reserves - downward slope
• —Banks demand fewer reserves as fed. Fund rate rises - bc make more money lending out

Fed inc. or dec. the SUPPLY of reserves by buying or selling securities in an open mkt. operation in order to RAISE or LOWER the rate (all S & D)

• —If demand is too high on a given day…Fed can lend at the discount rate (Spread above the fed. Funds target rate) in order to stop the mkt. fed. Funds rate from going too high - INC. SUPPLY TO DRIVE DOWN THE RATE
• – During crisis, fed purchased several securities to inc. supply of reserves to keep rate close to zero

Quantitative easing (QE) - the gap btwn the point where demand becomes flat and point at which supply curve intersects at the near zero IOER point
-----Caused reserves being held to inc. dramatically - excess reserves were 1300x larger in 2015!!!

Question 43

interest rate on excess reserves (IOER) rate

Answer 43

Int. rate paid by the Fed on reserves that banks hold in their accounts at the central bank in excess of reserve requirements

• —-Announced by the FOMC as the rate to be paid on all excess reserves
• —Changes int. Rates at which banks will lend and borrow

Fed now uses IOER rate to tighten monetary policy and inc. int. rates in fin. Mkts. - IOER becomes the top of the target range for fed. Funds rate - when FOMC announces inc. in fed. Funds rate…initiates change by raising the IOER rate - which raises the min. rate at which banks are willing to lend
—-Encourages banks to bid aggressively for funds from other participants in order to deposit them in their reserve accounts so they can take advantage of the higher int. rate paid by the Fed
—So when IOER rate inc., short term rates also inc.
○ So Fed sets monetary policy primarily by changing the IOER rate - it allows the FOMC to raise int. rates in the economy, which tightens fin. Conditions but does not alter supply of reserves
§ Way to set both the PRICE (int. rates) and quantity of product (aggregate reserves) it supplies

Question 44

discount rate

Answer 44

Int. rate charged by the Fed on its loans to banks
—- These loans provide liquidity to banks in times of crisis and are used to stabilize the fin. System rather than as a tool to alter day-to-day monetary policy

Question 45

reserve req.

Answer 45

The level of balances a bank is req. to hold either as vault cash or as a deposit at a Fed. Reserve bank

• –Set by the Fed reserve board within a legally imposed range
• –Influences the demand for reserves, not used to alter monetary policy

Question 46

Overnight reverse repo

Answer 46

• Also has an extra tool called the overnight reverse repo (ON RRP) rate - int. rate paid by Fed reserve on funds from nonbank intermediaries supplied via overnight reverse repurchase (repo) agreements - (repo is short term collateralized loan in which a security is exchanged for cash with agreement that parties will reverse transaction at specific future set date)
○ ON RRP works to keep the mkt. fed. Funds rate close to the IOER rate

Question 47

three types of DISCOUNT loans

Answer 47

1. primary credit
   - -extended on ST basis, usually overnight to credible sources
   - -CAMELS 1-2
   - –banks who rec. loan have to give collateral to Fed
   - –int .rate on pimrary osabove IOER rate - primary rate - penatly rate bc so high
   - -primary adds to fed’s supply of reserves at bank
2. secondary credit
   - -available to institutions that are not sufficienly sound to qualify for primary credit - in trouble
   - -secondary discount rate above primary rate
   - -need bc temp. shortfall in reserves
   - -this ty[e is rare - literally in desperation
3. seasonal credit
   - -used by banks in Midwest to manage cyclical nature of farmers loans and deposits

Question 48

At ECB comparing our tools to theirs

Answer 48

1. target int. rate and open market operations
   - -min. bid rate = min. int. rate accepted at reginancing auctions - equivalent of fed’s target fed dunds rate
   - -when reserved are plentiful - use rate similar to IOER rate
2. marginal lending facility
   - -similar to fed’s primar lending - discount lending
3. deposit facility
   - –banks with excess reserves at end of day deposit overnight in deposit facility at fed at rate set by ECB gov. council
4. reserve req.
   - -overnight cash rate - similar to mkt. fed funds rate - rate banks charge each other on overnight loans

Question 49

desirable monetary policy is (3 things)

Answer 49

1. observable - therefore accountable
2. controllable
3. tightly linked to objectives

inflation targeting - effort to improve monetary policy performance

• -use hierarchical mandate - price stability comes first and everything else comes second
• -most central banks use except us with dual mandate

Question 50

Tayalor rule

Answer 50

how to pick inflation target level/rate - FOMC uses taylor rule

• -target fed funds rate = natural rate of interest + current inflation + 1/2(inflation gap) + 1/2(output gap)
• -natural rate of int. = real short term int. rate that prevails when economy is using resources normally (2%)
• -inflation gap = current inflation - inflation target (As %) - find inflation info. using PCEPI
• -output gap % deviation of current output (real GDP) from potential output - potential is what economy is capable of producing when resources used at normal rates

FOMC usually chooses target fed funds rate that is really similar to rate predicted by taylor rule

Question 51

btwn Sept. 2007and Dec. 2008 - FOMC lowered target for fed funds rate 10 times!! what was target rate range by end of 2008?

Answer 51

0 - .25%

Question 52

reserves are injected into banking system through

Answer 52

an inc. in size of fed’s balance sheet

Question 53

if fed wishes to lower mkt. fed funs rate through open market operations, what will it do?

Answer 53

increase supply of reserves

Question 54

The Federal Reserve allows the market fed funds rate to fluctuate around its target within a corridor or channel. What serves as the ceiling for this corridor?

Answer 54

the discount rate

Question 55

Today, the reserve requirement exists primarily to _________________.

Answer 55

–stabilize demand for reserves and help fed maintain mkt. fed funds rate close to the target

Question 56

Euro. equivalent of fed funds rate is

Answer 56

min bid rate

Question 57

Central bankers use the term ___________________ to refer to instruments that are not directly under their control but lie instead somewhere between their policymaking tools and their objectives.

Answer 57

intermediate targets

Question 58

__________________ occurs when the central bank expands the supply of aggregate reserves to the banking system beyond the level that would be needed to maintain its policy rate objective.

Answer 58

quantitative easing

–large scale asset purchases