lecture 5- FI efficiency, credit spread and IS curve Flashcards
what is the discount rate?
the interest rate reserve banks charge commerical banks for short term loans
what are the 4 tools that the fed can use to achieve its monetary policy goals?
target federal funds rate
discount rate
reserve requirment/liquidity coverage ratio
interest on required reserve balances and excess balances
what is the target federal funds rate
It affects how freely banks can borrow money from each other, which in turn affects how much cash is available.
target federal funds rate is between 4.75-5%
what is the discount rate?
is the interest rate Reserve Banks charge commercial banks for short- term loans.
what is the reserve requirment?
Reserve requirements specify the amount of cash a bank must have close at hand in order to cover sudden withdrawals and protect the system from bank runs by depositors.
what is the liquidity coverage ratio?
the proportion of highly liquid assets that financial institutions must hold to ensure that they can meet their short-term obligations and ride out any disruptions in the market.
what is the interest on required reserve balances and excess balances?
The interest rate paid on required reserves, which are the minimum amount of cash a bank must keep on hand
The interest rate paid on excess reserves, which are any cash a bank holds beyond the required minimum
what does the market for bank reserves look like ?
the market for bank reserves has market federal funds rate on the y axis and quantity of reserves on the x axis
the reserve demand slopes downward
for levels of reserves less than the discount rate, the supply is vertical
for levels of reserve more than the discount rate, the supply is horizontal
which rate is important for the IS curve?
for the IS curve, the borrowing rate is important. the firms take loans from the banks at borrowing rate that is higher than the policy rate
financial intermediation defines the lending spread
what is the lending spread
A lending spread is the difference between the interest rate a borrower pays on a loan and a benchmark yield.
what is financial intermediation?
Financial intermediation is the process of moving funds from people or institutions with a surplus to those in need.
what does financial intermediation use as inputs and provide as outputs?
FI uses reserves as an input and generates loans as the output
what is reserve remuneration?
Reserve remuneration is the interest paid by central banks to banks for holding reserves.
what does the FI technology include?
The technology is complex, It includes
– The risk assessment of the borrowers
– The design of loan agreement with appropriate incentives
and covenant
– Monitoring of the business plan execution ( complaint with
the covenant)
– Renegotiation
– Definition of the risk premium to cover the losses
what is the formula for credit spread?
w=i^b-i^s where w is the credit spread/price for financial intermediation, i^b is the borrowing rate and i^s is the savings rate
