Money and Banking Exam 3

Commodity Money

a good with intrinsic value serves as money

Board of Governors: Selection

appointed by the President of US and confirmed by the senate

Who owns Federal Reserve Banks?

they are owned by the member banks within their district

The path from the FOMC policy rate to its Dual Mandate

- FOMC sets FFR Target -> - FFR affects market interest rates -> - Market interest rates affect consumers and producers -> - consumers and producers affect inflation and unemployment

Monetary Policy Tools

- Interest Rate on Reserve Banks (IORB) - overnight reverse repurchase (ON RRP) - Discount Rate - Open Market Operations

FOMC information

-When the FOMC sets the target range for the federal funds rate, the Fed then chooses a level of the interest on reserve balances rate that will encourage the market determined federal funds rate to be within the target range. -When the FOMC raises the target range for the federal funds rate, the Fed raises the interest on reserve balances rate, which moves the federal funds rate up into the new target range. -When the FOMC lowers the target range for the federal funds rate, the Fed lowers the interest on reserve balances rate, which moves the federal funds rate down into the new target range. -Interest on reserves balances is the Fed's primary tool for influencing the federal funds rate.

ON RRP rate (percentage)

.3%

What is the Fed's primary tool for implementing Monetary policy?

IORB

Monetary Aggregates: M1

M1 includes: - currency in-circulation - checking deposits - savings deposits

Overnight reserve repurchase agreement (ON RRP) facility

The Federal Reserve's standing offer to a broad set of financial institutions to deposit funds at the fed and earn interest - The ON RRP facility is a supplementary tool; the ON RRP offering rate acts like a floor for the FFR

Unit of Account

a yardstick for stating prices and values

The Federal Funds Rate (FFR)

the interest rate banks charge each other overnight loans of reserves. FFR is the Fed's Policy rate.

History of the Federal Reserve System

- Established by the Federal Reserve Act of 1913 to act primarily as a lender of last resort - powers split between financial and agricultural interests - earliest duties of the fed: lend to banks and control the volume of current outstanding - today their most important role is to conduct monetary policy

FFR rate (percentage)

.34%

IORB Rate (percentage)

.4%

Discount Rate (percentage)

.5%

Functions of the Federal Reserve Banks

1) serve as the US Treasury's Bank 2) serve as a bank for member banks 3) check clearing 4) Make loans to member banks (discount loans) 5) Regulate member banks

What is the discount rate?

An interest rate on which fed charges

Federal Open Market Committee: Members

FOMC has 19 members: - 7 BOG - 12 FRB Presidents

What does it mean to implement monetary policy?

Fed uses monetary policy tools to achieve its FFR target

What would the FOMC do if the economy experiencing high inflation and not meetings its maximum employment and price stability dual mandate?

IORB ^ -> FFR ^ -> Market Interest rate ^

Interest on reserves balances (IORB)

Interest paid on funds that banks hold in their reserve balance accounts at a Federal Reserve Bank - IORB is the Fed's primary tool for guiding the FFR

Monetary Aggregates: M2

M2 includes: - M1 - small time deposits - retail money market funds

The FOMC sets Policy

The FOMC sets a target for the federal funds rate (FFR) that is consistent with its goals of price stability and maximum employment

Discount window

The Federal Reserve's lending to banks (the "discount window") at the discount rate - The discount window helps put a ceiling on the FFR

Open Market Operations

The buying and selling of government securities by the federal reserve - Open market operations are an important tool for ensuring that reserves remain ample

How does the fed use open market operations to ensure reserves remain ample?

The fed can increase reserves by making open market purchases

Fiat Money

a good with no intrinsic value is used as money

Price Stability

a low and stable rate of inflation over an extended period of time. The Fed seeks to achieve inflation that averages 2% over time.

Board of Governors: Terms

governors serve 14-year non-renewable terms chair and vice-chair are chosen from the 7 governors, and serve 4-year renewable terms (chair of the BOG also serves as chair of FOMC)

Arbitrage

purchase a good at a low prince in one market and sell it at a higher price in another market - if the FFR > IORB, banks can lend in Fed Funds Market. This will drive FFR down toward IORB.

How does the interest on reserve balances rate serves as a reservation rate?

reservation rate is the lowest rate at which a bank can lend

Medium of Exchange

something that facilitates the exchange of goods and services. Soles the double coincidence of wants problem

Store of Value

something that holds its value overtime

Maximum Employment

the highest level of employment that the economy can sustain while maintaining low and stable inflation

Reservation rate

the lowest rate at which a bank is willing to lend reserves - if banks can earn IORB from the fed, they won't lend reserves to Banks at rates below IORB

How does the discount rate act as a ceiling for federal funds rate?

you will not go above the discount rate (aka the FFR will not)

IORB- interest rate on reserve balances

- IORB is the Fed's primary monetary policy tool - IORB is an administrative rate

How the IROB affects FFR

- IROB is a reservation rate - arbitrage

ON RRP (overnight reserve repurchase)

- an administrative rate -the ON RRP offering rate sets a floor for the FFR

The Fed has two co-equal goals:

- price stability - Maximum Employment

FFR Target Rate

.25-.5%

Functions of Money

1) Medium of Exchange 2) Unit of Account 3) Store of Value

What are the Fed's dual mandate goals?

Price stability and Maximum Employment

What does it mean to conduct monetary policy?

The FOMC voting on a federal funds rate target

The Discount Rate

- An administrative rate - Sets the ceiling for the FFR -The Discount rate is the interest rate the fed charges on loans that it makes to banks (discount loans)

The Market for Bank Reserves

- The Federal Funds Rate is determined in the market - The Fed supplies reserves - The Bank Demands Reserves

Open Market Operations

- The fed buys and sells US government bonds on the open market - Open market purchases increase the supply of reserves - Open market sales decrease the supply of reserves - Open market operations ensure an ample supply of reserves

Boards of Federal Reserve Banks

- each FRB has a president and a 9-member board of directors - each board consists of > 3 Class A members: bankers elected by member banks > 3 Class B members: non-bankers elected by member banks > 3 Class C members: non-bankers appointed by Federal Board of Governors (FRB Presidents chosen by Class B and Class C members, subject to the approval of the Board of Governors in Washington)

Federal Open Market Committee (FOMC): Voting

12 Voting Members - 7 BOG - 5 FRB Presidents

How does arbitrage ensure that the federal funds rate does not fall far below the interest on reserve balances rate?

Banks will rush to borrow

Give an example of banks arbitraging between the federal funds market and interest on reserve balances

Borrowing at one price and lending at a higher price