conventional monetary policy Flashcards
monetary policy
any action taken by a countrys monetary authority to steer the local economy
when is monetary policy said to be conventinoal
if it is limited to one of the four conventinoal tools AND if OMO are exlcusive to fine tune total amount of reserves held by depository institutions
four conventional tools
OMO
-reserve requirements
-discount rate
-interest on reserves
what is the main tool the fed used to use
open market operations
what are OMO instructed by
FOMC
what are OMO
purchases and sales of financial assets by the NY feds trading dek
when fed buys treasury bonds
they go up (more of that asset), use cash to pay and creates reserves
what happens when a typical bank sells financial assets
when you sell it goes down, sell for money in form of reserves (electronic)
what happens whne the fed buys US treasury securities (or any other asset)
it pays for said purchase by creating previously non-existent reserves -> fed grows
treasury bills
-bond gov promises to pay in one yr
-go away without fed selling is governemnt paying it off
what happens when the fed sells US treasury securities (or any other asset)
exisiting reserves are destroyed -> fed shrinks
histroically, vault cash/reserves required to be…
held ahainst a banks outstanding deposits (typically 10%)
excess reserves
vault cash in excess of a banks reserve requirements
histroically did we have excess reserves
no, so you could restrict banks on deposits they can make
bank run
when everyone leaves bank and takes out money
why was fed originally founded
to stop bank runs
-relied on private citizen JP morgan to save us
-congress said no more to that
why do banks under normal circumstances prefer to borrow reserves from other banks because
it is cheaper (normally) and because borrowing from the fed has historically been viewed as a sign of weakness
trade off of IOR
hold reserves with the Fed vs lend them to other banks
fed funds are
reserves borrowed from other banks
borrowed reserves are
borrowed from the fed
uncollateralized
just gotta trust
why in Fed 2023 inc interest rates a lot
to try to help price stability b/c price inc a lot
fed tries to influence
the economy
FFR is
reserves borrowed from bank
market rates are determined by
the market
commercial loan rates
loan to finance operation
market for fed funds
what banks lend to each other overnight
are non borrowed reserves fixed
yes
are borrowed reserves supplied at the discount rate
yes
what is banks fundamental trade off
-lend to fed at IOR
-lend to banks above IOR
as FFR gets high in market for fed funds
minimize holdings (vertical demand curve)
collateral
something you offer to secure a loan
profit between ___ and ___ is stronger incentive to lend and not hold in account
FFR; IOR
-idea is to hold as little reserves as possible
market for fed funds: as the fed increases NBR (via OMO) what happens to the quilibrium FFR rate
FFR falls
for market for fed funds (demand): demand for FF is decreasing in FFR because
the opportunity cost of holding reserves rises
demand for FF is perfectly eleastic at IOR because
banks are indifferent between lending reserves to other banks or keeping them
how fed used to work
fed increases suply of reserves by purchasing financial assets
-sell would decrease
how do purchase/sale of treasuries by the fed affect the prior graph? where would you expect FFR to beunder the current ample reserves system
today if you shift far right FFR would be lower at what IOR is
today fed does what to change interest rates
manipulate IOR to pin interest rates
why does fed not have super tight control on bank deposits
b/c they dont create deposits (they can make notes)
today the primary interest rate the fed uses to steer the economy is
the federal funds rate
how does fed set FFR tody
OMO, IOR, and DR
how do OMO, IOR, and RD infleunce FFR
IOR and DR serve as bounds while OMO can pricniplaly be used to find tune FFR between those bounds
under the ample reserves system what is the most important conventional tool
IOR
conventional monetary policy focused on
short term FFR
taylor rules
math equation to help us understand how Fed makes decisions
even without consulting the current tealbook can we oredict the feds FFR target
yes, taylor rule exists as a function of output + inflation
output and unemplyment are directly
proportional
does taylor rule work
yes
taylor rule uses what to solve for FFr
output gap (unemployment part) and inflation gap (price stability part)
-of dual mandate!
respond to (-) output gap by dec
FFR
implicaation of taylor rule
raise rates when output and/or inflation are overheating (ie rel. high)
why during volvker disinflation was weight of taylor rule 1/2
since volvker was a hawk
today what is the weight we use in taylor rule
1 (more dove like)
does modified or originial taylor rule follow fed behaviors better
Original
what version of taylor rule is used today, why?
modified
fed behaviors go into (-), and fed is unwilling to set interest rates at negative levels b/c incentive to convert e-money to cash (garuntees 0% interest rate)
what happens if Fed actually went negtive with interest rates
bank runs and that it would encourage people to borrow money
does FOMC solve global problems
no, it has five options that are versions of taylor rule. Guided decisions as seen in teal book
