Money and also Banking Test II Flashcards
To beast hard on this test and then purchase supreme foamposites like a boss and then take 3 blunts to the dome in honor of Janet Yellen being first female fed chair.
What led to the Central Bank being created in 1913
America had gotten rid of its central bank in 1811 which caused very uneasy financial markets. Without a central bank no lender of last resort. Thus there were regular bank panics in the US during the Nineteenth century. After a bank panic in 1907 caused catastrophic losses, the public convinced itself a central bank was needed.
The Federal Reserve System includes…
Federal Reserve Banks The Board of Governors of the Federal Reserve System The Federal Open Market Committee The Federal Advisory Council Member Commercial Banks
How many Federal Reserve Banks are there?
12
Open Market Operations
The purchase and sale of government securities that affect both interest rates and the amount of reserves in the banking system.
Discount Loan
A loan issued by a Federal Reserve bank to a member bank at an interest rate called the “discount rate”
Fed Member Banks
All national banks are required to be members of the Federal Reserve System
Currently about 1/3 of commercial banks are members of the Federal Reserve System
Board of Governors
A seven member committee that is based in Washington DC
Each is appointed by president of US and confirmed by Senate.
14 Year term
Must be from different districts.
The chairman of the Board of Governors is chosen among the seven governors (4 year term)
What are some of the responsibilities for Board of Governors
All seven governors are on the FOMC and vote on the conduct of open market operations.
Sets reserve requirements.
Effectively controls the discount rate by the “review and determination” process.
Advises the President on economic policy, testifies in Congress and speaks for the Fed to CNBC.
Federal Open Market Comittee
Typically meets 8 times per year. Makes decisions regarding the conduct of open market operations and the setting of the federal funds rate. Consists of seven governors as well as the presidents of the Federal Reserve Bank of New York and four other Federal Reserve Banks.
Federal Funds Rate
The interest rate on overnight loans from one bank to another.
Tightening
Any monetary policy that raises the federal funds rate.
Easing
Any monetary policy that lowers the federal funds rate.
Why is Fed Reserve Bank of New York Special?
All of the purchases or sales of securities are executed by the Federal Reserve Bank of New York at the directive of the FOMC.
Instrument Independence
The ability of the central bank to set monetary policy instruments, such as interest rates.
Goal Independence
The ability of a central bank to set the goals of monetary policy.
Why should the fed be independent?
-The decrease in autonomy would result in an inflationary bias to monetary policy.
-Would put pressure on the Fed for expansionary monetary policy before an election (may decrease the emphasis on long-run stabilization policies.
—–This is one of biggest reasons why governors serve 14 year terms
If Fed were controlled by politics it would be more volatile in its policy making to solve short term problems, leading to even worse long term problems
-Politicians are rarely economists and therefore don’t understand the intricate balances of the economy
Why shouldn’t the Fed be independent
-An independent agency that controls interest rates, which we are all subject to, is extremely undemocratic.
While independent, the Fed has not always used its freedom successfully or responsibly.
Structure of the ECB
- Central banks of each of the member countries act lie the Federal Reserve Banks
- It has an Executive Board that is similar to the Board of Governors, it is made up of a president, vice president, and four other members who serve eight year, nonrenewable terms.
- The Governing Council, which is comprised of the Executive Board and the presidents of the National Central Banks, works in much the same way as the FOMC
- Members of the Executive Board are appointed by a committee of the presidents from those nations in the European Monetary Union.
Differences between ECB and Fed
- . The budget of the Federal Reserve System is controlled by the Board of Governors, whereas the National Central Banks control their own budgets as well as that of the ECB.
- Monetary operations of the ESCB (European System of Central Banks) are conducted by the National Central Banks in each country, making monetary operation less centralized
- The ECB does not supervise or regulate financial institutions like the fed does.
Agents in the Money Supply Process
Central Bank
Banks
Depositors
Central Bank (agent definition)
The government agency that oversees the banking system and is responsible for the conduct of monetary policy
Banks (agent definition)
The financial intermediaries that accept deposits from individual and institutions and make loans.
Depositors
Individuals and institutions that hold deposits at banks.
Fed Balance Sheet Assets
Securities
Loans to Financial Institutions
Fed Balance Sheet Liabilities
Curren$y in Circulation
Reserves
Banking System Assets
Reserves
Securities
Loans
Banking System Liabilities
Checkable Deposits
Discount Loans
Monetary Base
Amount of Currency in circulation (C) plus total reserves in the banking system (R). MB = C + R
Currency in Circulation
Currency in circulation is the amount of currency in the hands of the non-bank public
Reserves
The deposits in banks’ accounts at the Fed along with the currency that the depository institution are holding, typically called vault cash
Required Reserves
Reserves that the Fed requires banks to hold
Excess Reserves
Additional Reserves held by the bank.
Required Reserve Ratio
For every dollar in a checkable deposit account, a certain percent of that must be held in reserves and cannot be issued as a loan.
Increasing the Fed’s holdings of securities will increase the money supply in two main ways…
Purchasing the securities directly from the Treasury, thus allowing the government to finance its expenditures.
Purchasing the securities from member banks or, in rare cases, the public; thus increasing the available funds for loans.
Borrowed Reserves
Loans from the Fed to Financial Institutions.
Appear as liability for financial institutions, bust as an asset for the Fed
Discount Rate
Interest Rate on loans from Fed to Financial Institution
Suppose that the Fed purchases $100 million of bonds from banks and pays them with a check for this amount. Describe the sequence of events (or the mechanism) that causes the money supply to either increase or decrease?
Banking System Assets: Securities- $100M Reserves+ $100M Federal Reserve System Assets: Securities +100M Liabilities: Reserves +100M Monetary Base has increased
Suppose that the Fed purchases $100M of bonds from the nonbank public, that is, individuals or corporations. Describe the sequence of events that causes the money supply to either increase or decrease.
We assume individuals or corporation who sold the securities deposits all of the check in a checkable deposit at a bank.
Nonbank Public
Assets: Securities -$100M Checkable Deposits +$100M
Banking System
Assets: Reserves +$100M
Liabilities: Checkable Deposits +$100M
-Increasing the Reserves in a banking system is an increase in the liabilities of the Fed
Federal Reserve
Assets: Securities +$100M
Liabilities: Reserves +100M
The monetary base increases by $100M
Suppose that the banking system needed to take out $100 M in loans from the Fed. Describe the sequence of events that led to the monetary base increasing or decreasing
A discount loan from the Fed to Financial Institution is an asset for Fed, liability for banking system. Banking System Assets: Reserves +$100M Liabilities: Discount Loans +$100M Federal Reserve System Assets: Discount Loans +$100M Liabilities: Reserves +$100M Monetary Base increases by amount of loan.
Multiple Deposit Creation
A function that describes the amount of money created in a bank’s money supply. This money is created by lending money that is in excess of its required reserve to borrowers.
1/RRR
How is Money Created in Multiple Deposit Creation
When Fed purchases bonds from a bank, their reserves at the fed increases, but their checkable accounts stays the same. This means that the bank can loan out 100% of what the fed pays them for the bonds. Thus starting the process of multiple deposit creation
Problems with Multiple Deposit Creation Method
Banks do hold onto some excess reserves and not all checks are fully deposited.
If banks decide to hold more reserves or currency model breaks down.
It gives maximum increase in deposits.
Money supply is ______ related to currency holdings
Negatively
The money supply is ____ related to required reserve ratio
Negatively
The money supply is _____ related to the level of borrowed reserves from the Fed
Positively
An increase in the nonborrowed monetary base will cause the money supply to ____
Increase
Money Multiplier
Formula for figuring out increases in monetary base.
M=(1+Currency Ratio)/(Required Reserve Ratio + Excess Reserve Ratio + Currency Ratio)
Consider a situation where the required reserve ratio is 10%, currency in circulation is $400 billion, checkable deposits total $800 billion and excess reserves total $0.8 billion.
rr=.10
c=0.5 (400/800)
e= 0.001 (.8/800)
(1+.05)/(.10 + .001 + .05) = 1.5/.601=2.5
Demand for Reserves
The price of holding reserves is the opportunity cost: the loss of revenue from lending those reserves out.
Therefore, when the FFR increases, the opportunity cost of holding reserves increases, and the quantity demanded falls.
Why is there kink in demand curve for reserves
Since Octover 2008, the Fed has paid interest on reserves held by banks. This interest payment is meant to decrease the implicit tax (cost of them not loaning it out) on required reserves as well as increase the proficiency of monetary policy. With the introudction of this interest payment, the demand for reserves will flatten out at that particular interest rate. If a federal funds rate is below the reserves rate banks will hold onto their reserves because they can earn more on them than on overnight loans.
What happens when FFR is below discount rate?
Banks would rather borrow reserves from each other than borrow from the Fed. This means that the borrowed reserves in the economy is near zero and the suppl;y is purely determined by non-borrowed reserves, which is controlled by fed.
Explain why the Supply Curve is vertical and horizontal?
- If FFR is below the discount rate, banks would rather borrow reserves from each other then the fed. This means that the borrowed reserves in economy is essentially zero, thus we get the vertical supply curve.
- When the FFR is higher than the discount rate borrowing from Fed becomes cheaper than borrowing from other banks. The banks will only borrow from the Fed, causing the borrowed reserves to rise, which fed has no control over. This causes the supply curve to be horizontal.
Feds Conventional Tools of Monetary Policy
Open Market Operations
Discount Lending
Reserve Requirements
Most Important Conventional Policy Tool
OPEN MARKET OPERATIONS
They are the primary determinants of changes in interest rates and the monetary base
Dynamic Open Market Operations
Intended to change the level of reserves and monetary base during normal times
Defensive Open Market Operations
Intended to offset changes in other factors that might disrupt the targeted interest rate or money supply.
Repurchase Agreement
The Fed purchases securities with an agreement that the seller will repurchase them in a short period of time, anywhere from one to fifteen days from the original date of purchase. This is mainly done for temporary fluctuations in money supply.
Matched Sale-Purchase Transaction
Often called a reverse repo, the Fed sells securities with the intent of buying them back in the near future.
The facility at which the banks can borrow reserves from the Federal Reserve is called the ________
Discount Window
Primary Credit
Rate of credit that healthy banks receive for loans with very short maturities. Usually about 100 basis points above the FFR.
Secondary Credit
Given to banks in financial trouble. About 50 basis points above primary credit
Seasonal Credit
Meant for banks in vacation or agricultural regions which may need added liquidity for only small periods in a given year.
Why is Fed lender of last resort
To quell financial panics and to provide reserves to the banking system when no one else would.
Interest on Reserves
- Newest policy tool
- Set below the federal funds rate.
- Considered as a floor below the FFR
Which is the best conventional policy tool
Open Market Operations
Why are traditional monetary policy tools ineffective during a financial crisis?
The financial system completely freezes up causing an inability to allocate capital to productive uses
The zero-lower-bound problem, in which central banks are unable to lower short term interest rates further because they are essentially zero
Term Auction Facility
Fed making loans at a rate set through competitive auction. Is a better alternative to taking discount loans which makes firm appear to be in desperate times.
During financial crisis fed also auctioned off loans to firms directly.
Quantitative Easing
Increase of Fed balance sheet
Credit Easing
What Bernanke used to describe efforts. The Fed has shifted the assets and liabilities of their balance sheet to better help specific credit markets. This is possible as Term Auction Facility went to specified industries and could help unfreeze particular credit markets.
Price Stability
Low and stable inflation
Nominal Anchor
A nominal variable such as the inflation rate or the money supply, which ties down the price level to achieve price stability. Adherence to a nominal anchor that keeps the nominal variable within a narrow range promotes price stability by directly promoting low and stable inflation expectations.
Time-Inconsistency Problem
Monetary policy that is conducted on a discretionary, day-by-day basis, leading to poor long run outcomes. Sacrificing long run goals for short term issues
Other goals of central bank besides price stability…
High Employment and Output Stability Economic Growth Stability of Financial Markets Interest Rate Stability Stability in Foreign Exchange Markets
Dual Mandate
fed focuses on price stability and high employment
Inflation Targeting
Acceptance of the price stability goal and use of nominal anchor.
Advantages of Inflation Targeting
Increased accountability of the central bank and will likely avoid time inconsistency trap.
Easily understood by the public, making it very transparent.
Disadvantages of Inflation Targeting
Delayed Signaling- Inflation outcomes revealed after substantial time has passed
Too Much Rigidity- Limits policy makers ability to respond to unforseen circumstances.
Potential for Increased Output Fluctuations- Might tighten too much due to inflation and effect output negatively
Low Economic Growth-
Monetary Policy Instrument
A variable that responds to the central bank’s tools and indicates the stance (easy or tight) of monetary policy.
Feds two basic policy instruments
Reserve aggregates
Interest rates
Taylor Rule
Used to select the proper FFR given some other economic data. Indicates that the FFR should be set equal to the inflation rate plus an “equilibrium” real feds fund rate plus a weighted average of the inflation gap and the output gap.
The Taylor Rule indicates that monetary authorities more than ________
The increase in the inflation rate
What are the 3 initiators of the financial crisis
Mismanagement of Financial Innovation/Liberalization
Asset-Price Boom and Bust
Increase in Uncertainty
