Macro-unit... Flashcards
If the fed purchases bonds in the open market this is the expected effect on bond prices
An increase
In the short run if the money supply increases we would expect the nominal interest rates to…
Fall
Prime interest rate
reference rate for a wide range of interest rates on short term loans to businesses and individuals, this involves higher and riskier loans and is therefore higher than the federal funds rate
Federal funds interest rate
Interest rate that banks charge one another for overnight loans of reserves
Quantative easing
The fed’s response to the zero lower bound problem. The fed purchases bonds in order to increase reserves in the baking system. It is not intended to lower interest rates. Quantative easing can also involve the purchase of GSEs
Pros of monetary policy
- Flexibility and political acceptability
- Stabilization tool
Cons of monetary policy
- Recognition and operation lags complicate timing
- Liquidity trap limits the effectiveness of expansionary policy
What does the fed do under expansionary policy?
They purchase securities from commercial banks and the public to inject reserves into the system. This lowers the federal funds rate and interest rates (including the prime rate).
The transaction demand for money is a vertical line because..
transaction demand does not vary with changes in nominal interest rates
What does the fed do under restrictive policy?
The fed sells securities via open market transactions. This removes reserves from the system and interest rates rise.
Zero lower bound problem
The constraint placed on the ability of a central bank to stimulate the economy through lower interest rates because nominal interest rates cannot go below zero
How does monetary policy affect GDP and price level?
Policy decisions affect commercial bank, which affect the money supply, which which changes the interest rate, which affects investment, which affects aggregate demand, which then affects the equilibrium real GDP and price level
Discount Rate
The interest rate that the federal reserve banks charge on the loans they make to commercial banks and thrifts
Four instruments of monetary policy
1) open market operation
2) reserve ratio
3) discount rate
4) interest on reserves
Goal of monetary policy
help the economy achieve price stability, full employment and economic growth
What does the balance sheet of the federal reserve list?
Collective assets and liabilities of the 12 federal banks
Assets
Treasury notes, bills and bonds
Liabilities
Reserves of commercial banks, treasury deposits, and federal reserve notes
Interest rates and bond prices are
Inversely related
Total demand for money=
transaction demand(varies directly with nominal GDP)+asset demand(varies inversely with interest rate)
FOMC
Federal Open Market Committee
- aids the board of governors in conducting monetary policy
- 7 members of the board of governors, the president of the NY federal reserve bank and 4 other presidents on a 1 year rotating basis
How is money created?
By making loans (convert IOUs (not money) into checkable deposits (money) and money is later destroyed when lenders repay bank loans
When banks buy securities
What does the ability to loan depend on?
Excess reserves
What does the bank use excess reserves for besides loans?
Buy bonds from the public
What happens when banks sell bonds?
Money vanishes because the public draws from their deposits
How do banks maintain liquidity?
By holding cash and excess reserves
How do banks earn interest?
By making loans and purchasing bonds
The fed pays interest (federal funds rate) on…
excess reserves
Can the system as a whole lose reserves?
No, only individual banks can lose reserves to other banks
Money multiplier
The multiple by which the banking system can lend on the basis of each dollar of excess reserves is the reciprocal of the reserve ratio
What happens to reserves when the fed buys bonds from banks?
They go up
What happens to reserves when the fed sells bonds?
Reserves go down
Determinant of supply on a money graph
The fed, supply curve is vertical
Does the interest rate affect transaction demand?
no, nominal GDP does
What aspect of money do assets relate to?
Store of value
Why is it called the fractional reserve system?
Because only a portion of checkable deposits are backed up
What does deposit insurance do?
Helps prevent bank runs
Wall Street Reform and Consumer Protection Act
Consolidates financial regulation, provides federal oversight of mortgage backed securities and creates the bureau of consumer financial protection
Main categories of financial services industry
Commercial banks, thrifts, insurance companies, mutual fund companies, pension funds, security firms, investment banks
Thrift
A savings and loan association
TARP
Troubled asset relief program which made emergency loans during financial crisis
Does money supply change when a bank creates a loan?
No
When a bank buys securities does money supply change?
Yes
Which side of a banking chart affects money supply?
The right side
What are the functions of the Federal Reserve?
1) Issuing currency
2) Setting reserve requirements and holding reserves
3) Lending to financial institutions and serving as an emergency lender of last resort
4) Providing for check collection
5) Acting as fiscal agent
6) Supervising banks
7) Controlling the money supply
Why is the fed an independent agency of the gvnmt?
To protect it from political pressure
What caused the financial crisis of 2007 and 2008?
- mortgage loan default
- collapse of financial institutions
- freezing up of credit availability
Securization
Process of slicing up and bundling groups of loans, mortgages, corp-bonds etc
Board of governors
7 board members, one member is replaces every 14 years
“monetary authorities”
12 Federal Reserve Banks
Central banks, bankers bank, quasi public banks
- blend private and public control
- issue currency
- 12 districts
NCUA
National credit union administration monitors credit unions
Government stabilizes purchasing power by
1) effective control over the supply
2) application of fiscal policy
What backs the money supply?
Money as debt (government can freely manage money supply without having it backed by gold), value of money (acceptability, legal tender, relative scarcity)
Functions of money
1) Medium of exchange
2) Unit of account (measures value)
3) Store of value (enables transferring purchasing power from present to the future)
Liquidity
The ease with which money it can be converted quickly into the most widely accepted form of money
Components of money supply
M1 and M2
M1
Narrowest definition of us money supply
1) currency in the hands of the public
2) all checkable deposits
M2
Saving deposits+small denominated time deposits+money market mutual funds held by individuals+M1
Characteristics of money
1) acceptability
2) durability
3) divisibility
4) portability
5) stability
6) uniformity
near-monies
Financial assets that are extremely liquid but not money
Required reserves
The funds that each commercial bank or thrift institution must hold in the federal reserve or as vault cash to meet the legal reserve requirement
Excess Reserves
Actual reserves-required reserves
Federal funds rate
The interest rates that the US banks and other depository institution charge one another on overnight loans made out of their excess reserves
Monetary multiplier
1/reserve requirement
the multiple of its excess reserves by which the banking system can expand checkable deposits and the money supply by creating new loans or buying securities
Liquidity Trap
A situation in a severe recession when the central bank’s injection of additional reserves into the banking system has little or no affect on lending borrowing investment or aggregate demand
Cyclical asymmetry
The idea that monetary policy may be more affective when slowing expansion and controlling inflation than in extracting the economy from a severe recession
ZIRP
Zero interest rate policy
Monetary policy when a bank sets interest rates near 0 to stimulate to economy
Taylor Rule
A monetary rule that would demand exactly how much the Federal Reserve system should change real interest rates in the response to divergences of real GDP from potential GDP and actual rates of inflation from target rates of inflation
