Study Guide Chapter 13 Flashcards
Federal Reserve’s duties
- Conducting the nation’s monetary policy
- Supervising and regulating banking institutions and protecting the credit rights of consumers
- Maintaining the stability of the financial System.
What is monetary policy?
Monetary policy refers to the actions undertaken by the Fed to influence the availability and cost of money and credit to promote national economic goals.
What are the 3 economic tools (or methods) of monetary policy used by the Fed?
- Open-market opterations
- Discount rate
- Reserve requirements
What is Open-market operations?
Open-market operation is the Fed’s principal and most effective tool for implementing monetary policy. Open-market operations involve the purchase and sale of US Treasury and federal agency securities. The purchase or sale of these securities results in an increase or decrease of money in circulation. Feds purchase securities = Money supply increase and interest rate decreases Feds sells securities = Money supply decrease and interest rate increase
Describe Open-market operations (example)
When the Fed decides to sell securities through open-market bulk trading, the FRS holds the funds received from the sale. This reduces the supply of money in circulation, which, in turn, causes a drop in loanable funds and causes interest rates to rise. Higher interest rates cause some business and individuals to postpone borrowing. As borrowing drops off, the economy slow down and inflation (if any) is reduced. When an increase in economic activity seems needed, the Fed buys securities, thereby releasing money back into normal circulation and increasing loanable funds.
What is Discount rate?
The second most commonly used method of controlling the supply of money is changing the discount rate. The discount rate is the interest rate charged to member banks for borrowing money from the Fed.
- Discount rate increased = fewer loans are made and money supply decreases
- Discount rate decrease = more loans are made and money supply increases
Describe the effect of Discount Rate
If the discount rate is increased, member banks have to pay a higher interest rate for money borrowed from their district bank. The higher interest rate is passed on in the form of higher interest rate to consumers. This reduces the number of loans made because consumers become more reluctant to borrow. Because increasing or decreasing the discount rate has the greatest impact on the cost of short-term credit, the discount rate is considered to be the least effective economic tool for influencing the interest rates of long-term real estate loans.
What is Reserve requirements?
The 3rd method the Fed uses to influence the supply of money is the reserve requirements. The reserve requirements are the amount of funds that an institution must hold in reserve against deposit liabilities. Institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks.
Describe Reserve requirments
Amount of funds that an institution must hold in reserve against deposit liabilities as determined by the Fed
- Reserve requirement increased = money supply decrease and interest rates increase
- Reserve requirement decreased = money supply increase and interest rate decrease
Primary Market
The market where securities or goods are actually created. Made up of primary lenders that originate new mortgage loans for borrowers.
Intermediation
A process practiced by financial thrift institutions that serve as financial intermediaries (middlemen) between depositors and borrowers. Intermediation occurs when thrift institutions accept depositors’ savings.
Thrift Institutions
Financial institutions that hold savings deposits
Disintermediation
Occurs when funds are withdrawn from intermediary financial institutions, such as banks and savings associations, and are invested in instruments yielding a higher return. Disintermediation is the process of bypassing the intermediary financial institution.
Freddie Mac Federal Home Loan Mortgage Corporation or FHLMC
- Created by congress in 1970 2. Government-owned enterprise 3. Subjected to regulatory oversight by both the Secretary of HUD & the Secretary of the Treasury Department. 4. Freddie Mac provides a secondary market for loans originated by SAs. 5. Most loans handled by Freddie Mac are conventional loans 6. Savings associations can sell qualified mortgages to Freddie Mac for cash, then use the cash to make new mortgage loans.
Ginnie Mae Government National Mortgage Association or GNMA
- Ginni Mae serves as a guarantor of mortgage-backed securities (MBSs)
- Ginnie Mae does not issue, sell or buy mortgage-backed securities or purchase mortgage loans.
- Ginnie Mae-approved private institutions issue the MBSs.
- In exchange for a fee, Ginnie Mae guarantees the timely payment of principals and interest to the investors.
- Ginnie Mae mortgage-backed securities are the only MBSs to carry the full faith and credit guarantee of the US government.
