Chapter 19 Flashcards
Discount Rate
is the interest rate financial institutions pay to the Federal Reserve to borrow reserves. (usually short term borrowing)
(almost always collateralized)
Reserve Requirements
is the ratio of bank reserves to deposits that a bank must hold according to law.
Lender of Last Resort
is the Federal Reserve, which acts as the ultimate source of funds, to banks and other financial institutions by providing reserves to prevent bank failures.
Open Market Operations
the purchase and sale of government securities by the Federal Reserve in order to control levels of bank reserves. Those aimed at defending a target level of reserves from outside influences are defensive open market operations; those aimed at changing the level of reserves are dynamic open market operations.
What are the three key interest rates?
- Prime Rate (set by commercial banks)
- Discount Rate (an administered rate, NOT open market rate)
- Federal Funds Rate (market determined)
Prime Rate
The interest rate that banks charge their “biggest and best” customers, although frequently a bank’s very largest customers pay rates below the prime rate.
Federal Funds Rate
the interest rate that banks charge each other on very short-term loans among themselves. Usually the loans are “overnight” - made on one day and paid back the next. The federal funds rate is not an administered rate; rather it is market determined.
Reserve Requirement characteristics:
- All depositor institutions must have RR
- 0% on first $9.3 million
- 3% on $9.3 - $43.9 million
- 10% in excess of this, can vary 8%-14%, emergency as high as 18%
- Lowering RR instantly creates ER, Raising RR instant deficiency
- Changes money multipliers in opposite directions
- RR is a very blunt tool, not for fine tuning
Discount Rate characteristics:
- lower rate makes funds more attractive, higher rate less attractive
- is a privilege not a right, Bank should borrow for NEED not profit
- change in discount rate confirms what is going on, more of a lagging tool.
Prime Rate characteristics:
- interest rate for most credit worthy borrowers
- prime rate largely determined by Fed Funds rate
- Directly affects lending rates
Federal Funds rate characteristics:
- Interbank loaning
- Unsecured loan
- until 2003 it was usually below discount rate
- supply reserves > demand, fed fund rate falls
- supply reserves < demand, fed fund rate rises
- target through OMO-buying, reserves rise, rate falls. Selling, reserves fall, rate rises.
Discount Rate characteristics:
- Rate Fed sets for borrowing
- done at discount window
- usually higher than Fed funds rate to discourage PROFIT
- lower rate more attractive, higher less attractive
What are the 3 tools of Monetary Policy?
- Reserve Requirements (blunt tool, not for fine tuning)
- Discount Rate (Lagging tool)
- Open Market Operations (best tool b/c there is more fine tuning)
Lender of Last Resort function
The Federal Reserve, which acts as the ultimate source of funds to banks and other financial institutions by providing reserves to prevent bank failures.
How has the Fed prevented abuse from banks?
Until 2003, to prevent abuse Fed had extensive surveillance and admin procedures and rates were below short term rates. New procedure has penalty rate about short term rates and made discount window more open.
