Chapter 15 Flashcards
Cost of excess reserves
opportunity cost, interest rate that could have been earned (irr) minus the interest rate that is paid on reserves (ior)
demand curve when iff > ior
downward demand curve
if FFR decreases, the opportunity cost of holding excess reserves falls, and the quantity demanded of reserves increases
demand curve when iff <= ior
demand curve becomes flat
banks don’t make overnight loans, they just add on their reserves to earn higher interest
two components of non-borrowed reserves
non borrowed resserves supplied by feds OMOs
borrowed reserves borrowed from fed
id
cost of borrowing from the Fed at the discount rate
Iff
cost of borrowing from other banks at FFR
supply curve if Iff<Id
vertical
banks will not borrow from fed and borrowed reserves are 0
supply curve if Iff >= Id
banks will borrow more at Id, and re-lend at Iff, horizontal supply curve
four tools of monetary policy
OMOs, discount rate, rr, interest on reserves
how does an open market sale impact FFR
FFR increases
only if Rs intersects Rd on downward slope
how does an open market purchase impact FFR
FFR decreases
only if Rs intersects Rd on downward slope
When does OMO have no impact on FFR
when Rs intersects Rd on flat section
if intersecion of Rs and Rd occurs on verticals section of Rs, how does discount rate impact FFR
it doesn’t, theres no effect
when does a change in the discount rate impact FFR
when the intersection of Rs and Rd occurs on the horizontal section of Rs
what happens to FFR when Fed raises rr
FFR rises
what happens to FFR when Fed decreases rr
FFR falls
when does changing the interest on reserves have an impact on the FFR?
when Rs intersects Rd on flat section
conventional monetary policy tools
open market operations, discount lending, reserve requirements
dynamic OMOs
strategies used by the Federal Reserve to increase or decrease the amount of money in circulation in the economy
defensive OMOs
a type of open market operation (OMO) that aims to change other factors that affect the monetary base and reserves of an economy
Repurchase agreement
Fed purchases the securities with an agreement that the seller will buy it back in less than 15 days.
Matched sale purchase transaction
Fed sells securities and buyers agree to sell them back in near future.
discount window
rate set above the fed fund rate to encourage borrowing from other banks so they closely monitor the credit risks
primary credit
given to healthy banks. They can borrow all they want at very short maturity from a primary credit facility at discount rate. (standing lending facility Lombard facility
Secondary credit
given to banks with financial difficulty in need of liquidity at a rate higher than discount rate to reflect the less-sound condition of the borrower.
seasonal credit
are given to the banks in vacation or agricultural areas.
most important motivation for creation of Fed
lender of last resort to prevent financial panics
How much does FDIC really cover?
provides insurance to only 1% of total deposits at a bank
large deposits over $250,000 aren’t covered
Fed uses interest on reserves to serve as the ______ for the FFR
floor
advantages of OMOs
− complete control over the volume of transactions,
− flexible and precise,
− easily reversed
− can be quickly implemented.
advantages of discount rate
− no longer binding for most banks (fed fund rate
is normally below discount rate)
− liquidity problems and Moral hazard
− increases uncertainty for banks.
advantages of discount rate
Lender of last resort in extraordinary situations
such as the Black Monday (Oct19,1987), Sept 11,2001, and the global financial crisis 2008.
advantages of interest on reserves
When banks accumulated a lot of excess
reserves, an increase in interest on reserve will rise the fed fund rate without needing a large open market operation
why can’t fed use conventional monetary policy tools during a financial panic?
- financial system unable to allocate capital to productive uses
- negative shock to economy can lead to zero-lower-bound problem
both situations - must revert to nonconventional monetary policy
Nonconventional monetary policies
liquidity provision
large scale asset purchases
forward guidance
liquidity provision
– Discount Window Expansion (lower discount rate from 1% to 0.5% above the fed fund target)
– Term Auction Facility (made loan at a rate determined by auctions)
– New Lending Programs ( to IBs )
large scale asset purchases
– Government Sponsored Entities Purchase Program – Long-term Treasury securities (QE2)
– QE3
Forward Guidance
Commitment to future monetary policy actions of keeping the federal funds rate at zero for an extended period, the Fed could lower the market’s expectations of future short-term interest rates, thereby causing the long-term interest rate to fall.
skepticism about quantitative easing
expansion of fed assets leads to expansion of MB and MS, stimulates the economy in the short run, and increases inflation in the long run
credit easing / benefits
to change the composition of the Fed balance sheet to improve the functioning of particular segments of the credit markets.
enables it to allocate capital to productive uses
it can lower the int rate on the securities even when the short run rate hits the zero lower bound.
