chapter 15: tools of monetary policy

lender of last resort

Fed's most important role. to prevent bank failures from spinning out of control, the Fed was to provide reserves to banks when no one else would, thereby preventing bank and financial panics. creates a moral hazard problem.

if the manager of the open market desk hears that a snowstorm is about to strike NYC, making it difficult to present checks for payment there and so raising the float, what defensive open market operations will the manager undertake?

a defensive open market sale

if the treasury has just paid a large bill to defense contractors and as a result its deposits with Fed fall, what defensive open market operations will the manager of the open market desk undertake?

a defensive open market sale

when the federal funds rate is at the interest rate paid on reserves

a rise in the interest rate on reserves raises the federal funds rate

excess reserves

additional reserves banks choose to hold. insurance against deposit outflows. cost of holding it is their opportunity cost

federal reserve lending

changes in borrowed reserve

open market operations

changes in nonborrowed reserves

primary credit

discount lending that plays the most important role in monetary policy

required reserves

equal to the required reserve ratio times the amount of deposits on which reserves are required

supply of reserves will just equal the amount of nonborrowed reserves supplied by the Fed, and the supply curve will be vertical if

federal funds rates remain below the discount rate

dynamic open market operations

intended to change the level of reserves and the monetary base

defensive open market operations

intended to offset movements in other factors that affect reserves and monetary base

primary cost of borrowing from the Fed

interest rate charged by the Fed on the loans, the discount rate, which is set at a fixed amount above the federal funds target rate and thus changes when the target changes

The Fed uses discounting to

keep bank failures from spreading

management of expectations / forward guidance

keeping the federal funds rate at zero for an extended period to lower the market's expectations of future short-term interest rates.

banking institutions in the European Monetary Union can borrow, against eligible collateral, overnight loans from national central banks at the

marginal lending rate

discount lending

most changes in the discount rate have no effect on the federal funds rate

zero-lower-bound problem

negative shock to the economy

nonconventional monetary policy tools

non-interest-rate tools to stimulate the economy. in three forms: 1. liquidity provision, 2. asset purchases, 3. commitment to future monetary policy actions

The Fed's most commonly used means of changing the money supply

open market operations

open market operations

open market purchase causes the federal funds rate to fall, whereas an open market sale causes the federal funds rate to rise.

standing lending facility

primary credit facility

disadvantage of quantitative easing as an alternative to conventional monetary policy when short-term interest rates are at the zero lower-bound

quantitative easing may not actually have the effect of increasing economic activity

Reserves demanded by banks

required reserves + quantity of excess reserves demanded

Open market sales

shrink the monetary base and reserves, thereby decreasing the money supply

repurchase agreement, repo

the Fed purchases securities with an agreement that the seller will repurchase them n a short period of time, anywhere from one to fifteen days from the original date of purchase.

matched sale-purchase transactions, reverse repo

the Fed sells securities and the buyer agrees to sell them back to the Fed in the near future.

borrowed reserves

the amount of reserves borrowed from the Fed

nonborrowed reserves

the amount of reserves that are supplied by the fed's open market operations

A decrease in the discount rate does not normally lead to an increase in borrowed reserve because

the equilibrium interest rate will still fall below the discount rate

discount window

the facility at which banks can borrow reserves from the Federal Reserve

when the Fed decrease reserve requirements

the federal funds rate falls

If the Fed increases interest rates enough

the flat portion of reserve demand will shift up such that it will raise the intersection point with the vertical portion of reserve supply. The equilibrium fed funds rate will increase with the higher interest on reserve level.

Quantitative easing

Expansion of the balance sheet. Leads to a huge increase in the monetary base, which result in an expansion of the money supply

When the Fed raises reserve requirements

Reserve demand curve will be shifted horizontally to the right, resulting in a higher equilibrium federal funds rate. leaves nonborrowed reserves unchanged and increases the federal funds rate

primary dealer

Specific set of dealer in government securities in open market operations that are conducted electronically.

advantages of using open market operations as a monetary policy tool

they are flexible and precise, they occur at the initiative of the Fed, they are easily reversed if mistakes are made.

conventional monetary policy tools

tools of monetary policy to control the money supply and interest rates. includes open market operations, discount lending, and reserve requirements.

Repurchase agreements

used to conduct most short-term monetary policy operations rather than simply buying and selling securities outright because they allow the Fed to easily adjust open market operations in response to daily conditions, and are temporary open market purchases that can be reversed.

Conventional monetary policy might not work

when there is a zero-lower-bound problem.

market for reserves

where the federal funds rate is determined