Chapter 12

What duties are assigned to the manager of the System Open Market Account?

the SOMA manager receives policy directives from the FOMC. They must take appropriate action in the form of security trading to meet the goal set by the FOMC in that directive, especially the target growth rate for the money supply.

Principal goals central banks pursue in order to carry out monetary policy?

1. Achieving maximum sustainable output and employment. 2. Promoting stable prices.

Principal channels through central bank influence the economy:

1. Changes in cost and availability of credit to business, consumers and governments. 2. Changes in volume and rate of growth of the money supply. 3. Changes in financial wealth of investors as reflected in market value of their stock, bonds, and other security holdings. 4. Changes in the relative prices of domestic and foreign currencies. 5. Changes in the publics expectations regarding future money and credit conditions and currency values.

Functions of the Federal Reserve Today:

1. Clear and collect checks. 2. Issue currency and coin. 3. Maintain a sound banking and financial system. 4. Serves as the government's fiscal agent/ 5. Carry out monetary policy. 6. Supplies extensive information about financial markets and institutions to the public.

What functions do central banks perform in a market-orientated economy.

1. Controlling the nation's money supply. 2. Stabilizing the money and capital markets. 3. Serving as a lender of last resort for financial institutions in need of reserves. 4. Maintaining the nation's payment mechanisms.

Excess Reserves:

Amount of reserves left over after we deduct required reserves fro total legal reserves. They may be used to make loans, purchase securities or for other purposes.

Required reserves:

Holdings of cash and deposits at the Fed that a depository institution must hold back to the publics's deposits.

Legal Reserves:

Consist of the amount of deposits each institution keeps with the Federal Reserve bank in its district plus the amount of currency and coin held in its vault. These requirements are set by the Board of Governors and Federal Reserve Banks.

Why are despit-type intermediaries able to create money?

Depository institutions offering checkable (transaction) despots have the ability to create and destroy deposits. They cannot create more deposit money than the volume of excess reserve it holds, but the banking system can create multiple amount of deposit money from any given injection of reserves by using excess reserves to make loans an purchase securities. The dollar volume of deposits and loans that the banking system can create for each new dollar of excess legal reserves injected in to the banking system is known as the deposit multiplier.

The Federal Open Market Committee

FOMC meets every 4 to 6 weeks to determine monetary policy and cost and availability of credit. The main tool used is open market operations, although at the meeting all tools of monetary policy is considered. FOMC will set target rates for the growth of the money supply.

What ways did the early Federal Reserve System differ from the Federal Reserve we see today?

Fed underwent a drastic change after The Great Depression in 1930's. Fed was more decentralized in 1910's and 20's with 12 Banks chartered and 24 branch banks. These regional banks possessed essential monetary tools and made key policy decisions. Central bankers promoted easy or tight credit condition by varying rate charged on loans from discount window. At the time this was the Fed's chief policy tool. The Fed's principal policy tool today was not important to the early Fed and the early Fed could not vary the reserve requirements on deposits. Changed allowed banks to secure Fed loans with government securities set u the 7 member Board of Governors, and set margin requirements on purchases of selected stocks and bonds.

What is meant by ECB?

Formed as a result of the European Union (EU), the European Central Bank is headquartered in Frankfurt, Germany and represents all member nations of the EU.

Why should the central bank like the Federal Reserve worry about money and credit growth?

If to reduced the rate of growth of the money supply, this policy will eventually slow down the growth of income and production in the economy due to reduction in demand for goods and services. If borrowers find credit not so readily available and expensive to obtain, they are going to restrain borrowing and spending for both capital and consumer goods , slowing down economy rate of growth and perhaps a reduction in inflationary pressures.

Distinction between excess and required reserves:

Important because it plays a key role in the growth of money and credit in the economy. Depository institutions offering checkable deposits have the unique ability to create an destroy deposits- which are an important component of money supply-at the store of a pen or computer key

The Board of Governors of the Fed:

Is the key administrative body of the Fed. Sets reserve requirements member bank deposits, reviews and approves the discount rate, sets margin requirements on securities purchases, and provides leadership for open market operations through FOMC.

Why ECB is likely to be the world's most important central banks:

Its territory and unique goal demonstrate ECB's power. Affects the economic lives of nearly 300 million European citizens. It has begun to shape the structure of interest rates on the continent and assisted the conversion to a common EU currency, the Euro. Principal goal is to pursue price stability while other central banks (like Fed Reserve) pursue economic goals.

What is the Federal Reserves primary job?

Monetary policy- control of the nations money and credit supply and the pursuit of interest rate levels that optimize economic welfare.

Why are the functions of the central banks important in the functioning of a market-oriented economic system?

Money supply control is important to minimize the dangers of inflation, while market stabilization is critical to assure a smooth continuous flow of funds from savings into investment to support economic growth. Service as a lender of last resort moderate liquidity pressure in the financial system. Support of the payments mechanism assures continuous business activity and trade without interruption or long delays.

What extent are the principal goals of central bank monetary policy consistent or inconsistent with each other?

Policies designed to promote some central bank goals may aggravate problems in attempting to pursue other goals. Policymakers must often compromise. (i.e. Credit restraint and high interest rates designed to cool off inflation may result in rising unemployment and slower rate of economic growth.

What ways can central bank influence the money and credit creation process?

Reserve requirements, the discount rate, open market operations, moral suasion, and margin requirements. The public influences the amount of leakages form the money creation process. Tie and savings deposits and cash all reduce the money multiplier and reduce amount of money created by given level of excess reserves. Treasury influences money creation through the ability to affect bak reserves as it collects taxes, sells securities and dispenses funds to cover the governments purchases of goods and services.

What is the principal targets of the monetary policy?

Reserves in the banking system- principally deposits at the central banks and currency and coin help in bank vaults-represent the principal target of monetary policy. This is because reserves are the raw material out of which banks and nonbank depository institutions make loans an purchase securities (create credit).

How is the ECB similar to the Federal reserve and how is it different?

Similar: principal goal is price stability and run by the President of the ECB Governing Council, like that of the Federal Reserve Chairman. Different: the Fed pursues other goals such as full employment and economic growth and that the Fed Chairman has more influence over the action son the bank than the President of the ECB Governing Council.

Monetary Policy Transparency:

The Fed's aim is to make monetary policymakers' intentions about current and future policy clear ("transparent") to the public. The central bank believes openness about what it is doing and why will help minimize the waste of resources cause by market players' decisions that may be misguided or may results for people trying to protect themselves against uncertain future monetary policies that they don't understand/cannot predict.

What are the Federal Reserve Banks expected to do in serving the public and the banking system?

The Reserve banks are the governments fiscal agent. This includes keeping the operating accounts of the Treasury, redeeming government securities, and accepting deposits of federal tax dollars. The Reserve bank must participate in all open market transactions for their system.

What factors reduce the money-creating abilities of the banking system?

The money creating abilities fall when banks choose to hold some excess reserves than lend out all of their excess funds in order to maintain a protective cushion to meet unexpected withdrawals without falling below their required reserve holdings. These desired excess reserves tend to grow in proportion to the volume of transactions deposits.