Powerpoints Flashcards
Assets (Bank Balance Sheet)
Reserves (Vault cash/Fed deps)
Investments
Loans (consumer, business, student)
Building
Liabilities + NW (Balance Sheet)
Deposits (Checking Deposits Savings MMDA CDs IRAs)
Borrowings
Net worth
T-Account shows what?
Shows change in balance sheet
Loans on left; Deposits on right
Lent Funds to Borrowers
Loans (consumer, business, student)
Surplous Funds from Savers
Deposits (checking deposits, savings, MMDA, CDs, IRAs)
Assets =
Liabilities + NW
Bank Run
Many depositors simultaneously decide to withdraw money from a bank
Bank panic
Many banks experiencing bank runs at the same time
Fractional reserve banking system
A banking system in which banks keep less than 100 percent of deposits as reserves
Monetary policy
The actions the Federal Reserve takes to manage the money supply and interest rates to pursue economic objectives
Three monetary policy tools:
- Open market operations
- Discount policy
- Reserve requirements
Open market operations
The buying and selling of Treasury securities by the Federal Reserve in order to control the money supply
Federal Open Market Committee (FOMC)
The Federal Reserve committee responsible for open market operations and managing the money supply
Discount loans
Loans the Federal Reserve makes to the banks
Discount rate
The interest rate the Federal Reserve charges on discount loans
FED RES assets
FX reserves
Treasury bonds
Disc. loans
Fed reserve Liabilties + NW
Currency in Circulation
Required Reserves formula =
10% x CHK Deposits
Reserves =
Required Reserves + Excess Reserves
Vault cash + Deposits at Fed Res
Bank assets
Reserves
Treasury bonds
Loans
Bank liabilities + NW
CHK deps.
Savings
MMDA
CDs
The act of originating a loan is ___________________
the act of creating money
Change in checking deposits =
1/r x change in reserves
Equation of Exchange
M x V = P x Y
If Change in M/M is greater than change in Y/Y then
Change in inflation > 0
Deflation leads to:
Households postpone spending
Rising real interest rates
Rising debt burdens
Hoarding money =>
deflation
Austerity =>
stagnation/deflation
Deflation =>
lower wages => rising debt burdens
Taylor rule
A rule developed by John Taylor that links the Fed’s target for the federal funds rate to economic variables
Inflation targeting
Conducting monetary policy so as to commit the central bank to achieving a publicly announced inflation
What is the Velocity of money
The rate of money turnover
link between M & PY
Short run Phillips Curve is not ________________________
a structural economic relationship
not a permanent long-run tradeoff
not a reliable menu of change in inflation & U.R. combinations in the long run
QE-2 statement
The open market trading desk will continue to reinvest principle payments from agency debt and agency MBS ($300 billion over next 8 months)
QE2 Financial Effects:
- Lower nominal interest rates (Treasury, corporate, mortgage) if the fall in real interest rates exceeds the rise in inflation expectations
- Lower real interest rates
- Lower dollar exchange rate
- higher stock prices
- higher inflation expectations
Nominal interest rates =
real interest rates + inflation expectations
QE2 Real Economy Effects
Additional 2011 economic growth of 0.6%
Additional 2011 job growth of 500,000 Lower 2011 unemployment rate by 0.4 percentage points
Debt refinancings will lower debt burdens and repair households and firms balance sheets
Rising exports
Chase investors into riskier assets
Higher stock prices will encourage additional business capital expenditures and hirings
Higher stock prices will boost household net worth, reducing savings rates and boosting consumption spending
Lower corporate risk premium => increase capital formation => job creation
Rising inflation => rising nominal returns on investment
Rising inflation expectations => boost consumption spending today at the expense of future consumption
Rising inflation expectations => falling real interest rates => rising consumer spending and business investment
QE-2 Costs/risks
May send signal to investors the Fed is panicking
The Fed is “pushing on a string” as demonstrated by the large holdings of excess reserves
Fed is monetizing the additional Treasury debt through June 2011
Low U.S. yields will chase capital abroad, appreciate foreign currencies, create global economic distortions. For example, asset price bubbles and excess accumulation of reserves.
QE2 will not significantly lower nominal interest rates: lower real interest rates will be offset by higher inflation expectations.
Falling dollar will decrease the Chinese Yuan because of its peg.
Low interest rates are suppose to mobilize resources, but it could misallocate resources.
Low interest rates may boost the economy today, only to collapse it tomorrow.
Low interest rates subsidize borrowers at the expense of savers.
Competitive Quantitative Easing – Countries competing by printing more money to reduce exchange rates. This is inherently unstable. Someone must lose share of world trade at expense of others who gain share.
Trade Wars – Boosting export strategy can turn into blocking imports policy
Gold bubble
QE-2 won’t work because households and firms are repairing and deleveraging their balance sheets.
Firm’s cash stock piles are at record levels
Fed’s determination to avoid deflation could actually cause deflation: ELEP is a sign the Fed expects underemployed resources for an “extended period” => private sector pessimism => business expect investments to fail and households expect falling prices => cash hoarding => weak economy => deflation.
Monetary policy options to prevent deflation and increase inflation expectations
- Quantitative easing: print money to buy long-term government debt
- Buy private-sector debt
- Change expectations by announcing it will keep short-term rates low for a long time
- Raise its long-run inflation target
(encourage borrowing, discourage cash hoarding) - Reduce the interest rate paid on excess reserves.
- Move from inflation targeting (rate of change) to price level targeting
Anticipated inflation is __________________; Unanticipated inflation is __________________
expected and built into planning
unexpected and disrupts planning
Unanticipated inflation outcomes:
Alters expected outcome of long-term projects
Reduces long-term investment
Distorts the information in prices — reduces the effectiveness of markets
Results in actions based on price anticipation, instead of production
Borken Investment Banking Model
Deregulation + Leverage + Mortgage Securitization + Falling Home prices
Mortgage Securitzation
Seperationf of loan organization from loan holder
Assets: investment banks
MBS/ABS/CDO/ CLOs
-illiquid, long-term
Liabilties + capital: investment banks
Wholesale funding base
- commercial paper
- repurchase agreements
(unstable, non-insured, short term)
Credit crunch factors
Subprime/jumbo mortgage default concerns
Balance sheet asymmetric information
Weakening economy
Between 2006 to 2008, funds _________
dried up
Washington Maxim:
Temporary solution => Permanent fixture
Repurchase Agreements
(Repo)
Sale and purchase of securities agreement
Repo =
Cash transaction + Forward agreement
Reverse Repo:
Fed initially drains reserves
Adds reserves back later
Used to target i
Repo facts:
Repos began in 1917 by Fed to lend to banks
$5 trillion Repo market today
Secured cash loan
Legal transfer of security to lender
Repurchase prices > original prices (gap=interest)
1-7 day term typically, up to 2 years
Typically over collateralized to mitigate credit risk
Fede describes transaction from the counterparty’s viewpoint, rather than from their own
Why are exchange rates important?
Because they affect the relative price of domestic and foreign goods
Currency appreciates =>
country’s good prices increase abroad => foreign good prices decrease in that country
If currency appreciates, two points:
- Makes domestic businesses less competitive
- Benefits domestic consumers
If PPP holds, then no ____________________
arbitrage profit opportunities
If not PPP, then _______________
arbitrage profit opportunities exist
Purchasing power parity
E (exchange rate) will adjust so that it is possible to buy the same market basket of G/S with the equivalent amount of any country’s currency
Dollars and gold are _________________
currency substitutes
- both serve as a store of value
- a fall or expected fall in the value of the dollar create incentives to shift towards gold
J.M Keynes viewpoints
Advocated the use of fiscal and monetary measures to offset recessions
AD determines the overall level of economic activity
The modern capitalist economy does not automatically work at top efficiency, but can be raised to that level by government intervention
F.A. Hayek viewpoints
Changing prices communicate signals to enable individuals to coordinate their plans. This lead to an efficient exchange and use of resources
Leading critic of collectivism/socialism because it required a central planner that would eventually become totalitarianism
The free price system is a spontaneous order- the result of human action, but not of human design
Central banks do not possess the relevant info to govern the money supply, nor the ability to use it correctly
