CHAPTER 15 - Monetary Policy

Interest Rate Stability

- Like fluctuations in price levels, fluctuations in interest rates make planning and investment decisions difficult for households and firms. - The Fed's goal of interest rate stability is motivated by political pressure and a desire for a stable financial environment. - Sharp interest rate fluctuations cause problems for financial institutions. (fluctuations in interest rates make planning and investment decisions difficult for households and firms.) So, stabilizing interest rates can help to stabilize the financial system.

Frictional unemployment

- unemployment that occurs when people take time to find a job enables workers to search for positions that maximize their well-being

The demand and supply of the FFM graph (y-axis = federal funds rate iff; x-axis = quantity of reserves) (with Limited Reserves; before 2008)

1. Demand for Reserves • determined by the banking system First segment starts as a linear function line with a negative slope (starting point is at the interest rate of discount rate) Second segment continues a constant line where its y-value = interest rate the Fed pays on reserves (IORB) 2. Supply of Reserves • controlled by the Fed First segment starts a vertical line starting from IORB to interest rate on discount rates. Second segment continues as a constant line parallel to the demand line where its y-value = interest rate on discount rates

Open Market Purchase final summary from book

In summary, assuming that reserves are scarce, an open market purchase of securities by the Fed => decreases the federal funds rate. An open market sale of securities => increases the federal funds rate.

Changes in the required reserve ratio (rD)

- The Fed rarely changes the required reserve ratio. - The Fed will likely carry out offsetting open market operations to keep the target for the federal funds rate unchanged - The Fed lowered the required reserve ratio to 0% in March 2020 A) If the other factors underlying the demand and supply curves for reserves are held constant, an increase in the required reserve ratio shifts the demand curve to the right because banks have to hold more reserves. As a result, the equilibrium federal funds rate increases, and the equilibrium level of reserves remains unchanged.

Demand for reserves (from the book) (P1)

- The demand curve for reserves, D, includes banks' demand for both required reserves, RR, and excess reserves, ER. - The demand curve is drawn assuming that factors other than the federal funds rate—such as other market interest rates or the required reserve ratio—that would affect banks' demand for reserves are held constant. - As the federal funds rate, iff , increases, the opportunity cost to banks of holding excess reserves increases because the return they could earn from lending out those reserves goes up. So, as the federal funds rate increases, the quantity of reserves demanded declines. The result is that banks' demand curve for reserves is downward sloping. - As with other types of loans, we would expect that the higher the interest rate, the lower the quantity of loans demanded.

Foreign Exchange Market Stability

- A stable dollar simplifies planning for commercial and financial transactions. - Fluctuations in the dollar's value change the international competitiveness of U.S. industry (A rising dollar makes U.S. goods more expensive abroad, reducing exports.) - In practice, the U.S. Treasury often originates changes in foreign exchange policy, and the Fed implements these policy changes.

Forward Guidance

- Refers to statements by the Federal Open Market Committee (FOMC) about how it will conduct monetary policy in the future. - Monetary policy needs to affect long-term interest rates, which have a greater effect on the spending of households and firms.

The 6 monetary goals of the FED:

1. Price stability 2. High employment 3. Economic growth 4. Stability of financial markets and institutions 5. Interest-rate stability 6. Foreign exchange market stability

Categories of Discount Loans

1. Primary Credit 2. Secondary Credit 3. Seasonal Credit

New Tools When Facing a Zero Lower Bound on the Federal Funds Rate (section)

1. Quantitative Easing (QE) 2. Forward Guidance

QE (part 1)

- A central bank policy whose goal is to stimulate the economy by buying long-term securities. - 2009 to early 2010: The Fed bought more than $1.7 trillion in mortgage-backed securities and long-term Treasury securities - November 2010 to June 2011 (QE2): The Fed bought $600 billion in long-term Treasury securities - September 2012 to October 2014 (QE3): The Fed focused on buying mortgage-backed securities - March 2020: The Fed purchased $700 billion of Treasury and mortgage-backed securities

more about Price Stability from the book

- A market economy relies on prices to communicate information about costs and about demand for goods and services to households and firms. Inflation makes prices less useful as signals for resource allocation because households and firms have difficulty distinguishing changes in relative prices—which guide decision making—from changes in the general price level due to inflation. - (for point 3) as when lenders suffer losses when inflation is higher than expected or when retired people on fixed-dollar-amount pensions suffer unexpected declines in purchasing power.

more info on ON RRP from the book

- A repurchase agreement (or repo) is a short-term loan backed by collateral. With a repurchase agreement, the Fed buys a security from a financial firm, which promises to buy it back from the Fed the following day. - With a reverse repurchase agreement (sometimes called a matched sale-purchase agreement or reverse repo), the Fed does the opposite: It sells a security to a financial firm and promises to buy back the security the next day. - With a reverse repo, the Fed is essentially borrowing funds overnight from the firm that purchases the security. By raising the interest rate it is willing to pay on these loans, the Fed reduces the willingness of the firms it deals with in these transactions—its counterparties—to lend at a lower rate. - The Fed refers to overnight reverse repurchase agreements as ON RRPs and the interest rate on these securities as the ON RRP rate.

More info from the book about the current management of the FFR

- As a result, the Fed's previous method of controlling the federal funds rate by increasing or decreasing reserves through open market operations is no longer effective. Instead, as we mentioned previously, the Fed has used two other policy tools: (1) the interest rate it pays on bank reserve balances, iORB. (2) the interest rate it pays on its overnight reverse repurchase facility, iONRRP. - the Fed believed that the iORB would put a floor under the federal funds rate: That is, it would prevent the effective federal funds rate, from falling below the iORB . - This expectation turned out to be incorrect, however, because financial institutions such as the government-sponsored enterprises (GSEs) Fannie Mae, Freddie Mac, Federal Agricultural Mortgage Corporation (Farmer Mac), and the Federal Home Loan Banks (FHLBs) are eligible to borrow and lend in the federal funds market, but their deposits with the Fed do not receive interest.

More info from the book about the current management of the FFR (part3)

- As of July 2020, in addition to the 24 primary dealers—which can also participate in reverse repurchase agreements with the Fed—58 other financial institutions were eligible to be counterparties on these agreements. - These institutions included the GSEs—Fannie Mae, Freddie Mac, Farmer Mac—and the FHLBs, and investment companies such as Fidelity, Vanguard, Charles Schwab, and Black Rock. Note that some of the investment companies, including Vanguard and Fidelity, are not eligible to borrow and lend in the federal funds market. - However, by accepting them as counterparties on overnight reverse repos, the Fed ensures that the interest rate it sets on these securities will have a wider effect on other short-term interest rates. - For example, many of these investment companies operate money market mutual funds. Being able to earn a higher interest rate on overnight reverse repos with the Fed makes it possible for these companies to offer higher interest rates on their money market funds

The Fed's Monetary Policy Tools Over Time - Implementing Open Market Operations (part 3)(from the book)

- How does the account manager know what to do? a) The manager interprets the FOMC's most recent policy directive, holds daily conferences with two members of the FOMC, and personally analyzes financial market conditions. b) If the level of reserves needs to be increased over the current level, the account manager orders the trading desk to purchase securities. c) If the level of reserves needs to be decreased, the account manager orders the trading desk to sell securities

More info from the book about the current management of the FFR (part2)

- In December 2015, it began to matter that the didn't actually provide a floor for the federal funds rate. In that month, the Fed decided to increase its target for the federal funds rate above the 0% to 0.25% range that had been in place since December 2008. - Now the Fed needed an interest rate that would provide a true floor; that is, the Fed needed a way to be sure that the GSEs and other firms lending in the federal funds market that were not eligible to receive iORB wouldn't force the effective federal funds rate too far below the iORB - The interest rate the Fed pays on its overnight reverse repurchase facility, iONRRP serves this purpose because financial firms that aren't eligible for iORB (and so are willing to lend in the federal funds market below that rate) are eligible to receive iONRRP (and so aren't willing to lend in the federal funds market below that rate).

more on the forward guidance from the book

- That long-term interest rates, such as the interest rate on the 10-year Treasury note, depend partly on investors' expectations of future short-term rates. - If the FOMC convinces investors that the committee will act to keep short-term interest very low for several years, then long-term interest rates will be lower than they would have been without the guidance. - Note that forward guidance works only if FOMC statements are credible to investors—that is, if investors believe that the FOMC will actually take the stated actions in the future.

High Employment (or an acceptable low rate of unemployment)

- Unemployment reduces output and causes financial and personal distress. Even under the best economic conditions, some frictional and structural unemployment remains. (The tools of monetary policy are ineffective in reducing these types of unemployment.) - Instead, the Fed attempts to reduce cyclical unemployment associated with business cycle recessions. • Unemployment rate at full-employment is around 3-5%.

Stability of Financial Markets and Institutions

- When financial markets and institutions are not efficient in matching savers and borrowers, the economy loses resources. - The stability of financial markets and institutions makes possible the efficient matching of savers and borrowers. [ Some firms will be unable to obtain the financing they need to design, develop, and market goods and services. Savers waste resources looking for satisfactory investments. The stability of financial markets and institutions makes possible the efficient matching of savers and borrowers. ] - The Fed responded vigorously to the financial crisis that began in 2007, but it initially underestimated its severity and was unable to avoid the deep recession of 2007-2009. - The severity of the 2007-2009 recession has made financial stability a more important Fed policy goal.

Demand for reserves (from the book) (P2)

- When the Fed first began paying interest on reserves in October 2008, it believed that the interest rate, IORB, it paid on banks' reserve balances effectively put a floor under the federal funds rate. Therefore, we show the demand curve for reserves becoming horizontal (or perfectly elastic) at the interest rate IORB . The Fed reasoned as follows in considering to be a floor under the federal funds rate: - Suppose that the Fed is paying banks 0.75% on their reserve balances, but the federal funds rate is only 0.30%. Banks could borrow funds in the federal funds market at 0.30%, deposit the money in their reserve balances at the Fed, and earn a risk-free 0.45%. - Competition among banks to obtain the funds to carry out this risk-free arbitrage would force up the federal funds rate to 0.75%, which is the rate at which banks could no longer earn arbitrage profits. *** this analysis needs to be qualified, however, because it does not take into account that there are some nonbank financial institutions, such as Fannie Mae and Freddie Mac, that are eligible to participate in the federal funds market but are not eligible to receive interest on deposits with the Fed.***

The Fed's Monetary Policy Tools Over Time - Implementing Open Market Operations (part 2)(from the book)

- because reserves are no longer scarce, open market operations by themselves are no longer capable of bringing about a change in the FOMC's target federal funds rate. - Each morning, the trading desk notifies the primary dealers of the size of the open market purchase or sale being conducted and asks them to submit offers to buy or sell Treasury securities. The dealers have just a few minutes to respond. - Once the dealers' offers have been received, the Fed's account manager goes over the list, accepts the best offers, and then has the trading desk buy or sell the securities until the volume of reserves reaches the Fed's desired goal. - These securities are either added to or subtracted from the portfolios of the various Federal Reserve banks, according to their shares of total assets in the system.

Structural unemployment

- unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one refers to unemployment that is caused by changes in the structure of the economy, such as shifts in manufacturing techniques toward automation, increased use of computer hardware and software in offices, and increases in the production of services instead of goods.

New Monetary Tools (after 2008) (section)

1. Interest on reserve balances (IORB) 2. Overnight reverse repurchase agreement (ON RRP) facility 3. Term deposit facility

Changes in discount rate

1. Since 2003, the Fed has kept the discount rate higher than the target for the federal funds rate. 2. So, the discount rate is a penalty rate, which means that banks pay a higher interest when borrowing from the Fed than when borrowing from other banks in the federal funds market. 3. As a result, changes in the discount rate have no independent effect on the federal funds rate. In the reserves market graph, the horizontal portion of the supply curve is always above the equilibrium federal funds rate.

Traditional Monetary Policy Tools (section)

1. open market operations 2. discount policy 3. reserve requirements

more info on stability of FM and Institutions

Although the Fed also responded vigorously to the financial crisis that began in 2007, it initially underestimated the severity of the crisis and was unable to head off the deep recession of 2007-2009. The financial crisis led to renewed debate over whether the Fed should take action to forestall asset price bubbles such as those associated with the dot-com boom on the U.S. stock market in the late 1990s and the U.S. housing market in the mid-2000s. Fed policymakers and many economists have generally argued that asset bubbles are difficult to identify ahead of time and that actions to deflate them may be counterproductive. But the severity of the 2007-2009 recession led some economists and policymakers to reassess this position. In 2020, in response to the Covid-19 pandemic the Fed implemented a series of initiatives focused on maintaining the flow of funds through the financial system. Financial stability has clearly become a more important Fed policy goal.

more info from the book (M.tools)(2007-2009)

During the 2007-2009 financial crisis, the Fed introduced five new policy tools. The Fed continued to use these tools during the 2020 Covid-19 pandemic. Three of the tools are connected with bank reserve accounts and controlling the federal funds rate. The other two tools were introduced to deal with the zero lower bound problem mentioned in the chapter opener. Once the Fed has driven its target for the federal funds rate close to zero, it needs other means to help expand production and employment during a recession.

The Fed's Monetary Policy Tools Over Time - Implementing Open Market Operations (part 4)

Dynamic open market operations and Defensive open market operations "For example, when the U.S. Treasury purchases goods and services for the federal government, it does so by using funds in its account at the Fed. As the sellers of those goods and services deposit the funds in their banks, the supply of reserves in the banking system increases."

Example of Term deposit from book

For example, in August 2019, the interest rate on the Fed's auction of $1.7 billion in seven-day term deposits was 2.11%, which was higher than the interest rate of 2.10% the Fed was paying on reserve deposits. The term deposit facility gives the Fed another tool for managing bank reserve holdings. The more funds banks place in term deposits, the less they will have available to expand loans and the money supply. The Fed uses the term deposit facility infrequently, making it the least important of the Fed's three new monetary policy tools for managing the federal funds rate.

Term deposit facility

GOAL = to again effect a banks' holding of R (made after 2008, but no longer used anymore as much) Similar to certificates of deposit, the Fed's term deposits are offered to banks in periodic auctions. The interest rates have been slightly above the interest rate the Fed offers on reserve balances. The more funds banks place in term deposits, the less they will have available to expand loans and the money supply

ON RRP transactions

PHASE 1 = the FED sells securities (bonds) to counterparty, and they pay for the security PHASE 2 (OVERNIGHT) = the FED buys back the security from the counterparty, and then they receive money from the return on the sec. and the interest rate( i )

Open Market Operations

PURCHASE - FED gives money to primary market dealers from buying bonds from them => with the goal of increasing reserves SALE - FED buys the bonds from primary market dealers and they receive money => with the goal of decreasing reserves (primary market dealers' reserves are being affected) [Traditionally, the Fed concentrated on purchases and sales of Treasury bills, with the aim of influencing the level of bank reserves and short-term interest rates.]

How the Fed Currently Manages the Federal Funds Rate (section)

Path from the FOMC policy rate target to the Fed's dual mandate: • The FOMC sets the target range for the federal funds rate. • This affects market interest rates and overall financial conditions. • This also influences the decisions of households and businesses. • It ultimately affects employment and inflation.

Commercial Paper Funding Facilities

The Fed purchased three-month commercial paper directly from corporations so they could continue normal operations. - When Lehman Brothers defaulted on its commercial paper in October 2008, many money market mutual funds suffered significant losses. As investors began redeeming their shares in these funds, the funds stopped buying commercial paper. - Many corporations had come to rely on selling commercial paper to meet their short-term financing needs, including funding their inventories and their payrolls. By buying commercial paper directly from these corporations, the Fed allowed them to continue normal operations. - closed in 02/2010 after being established in 10/2008

Term Asset-Backed Securities Loan Facilities (TALF)

The New York Fed extended three-year or five-year loans to help investors fund the purchase of asset-backed securities. - These securities are securitized consumer and business loans, apart from mortgages. - For instance, some ABS consist of consumer automobile loans that have been bundled together as a security to be resold to investors. Following the financial crisis, the market for ABS largely dried up.

Interest on reserve balances (IORB)

The interest the Fed pays on the funds that banks hold in their reserve balance accounts at Federal Reserve Banks. This is the Fed's principle monetary policy implementation tool. 1. By paying interest on reserve balances, the Fed gains a greater ability to influence banks' reserve balances. 2. By raising the interest rate it pays, the Fed can increase banks' holdings of reserves, potentially reducing banks' ability to increase the money supply. 3. By reducing the interest rate, the Fed can have the opposite effect. GOAL = Effect banks' holding of reserves. The interest rate the Fed pays on reserves can help put a floor on short-term interest rates because banks will typically not lend funds elsewhere at an interest rate lower than the rate they can earn on reserves deposited with the Fed.

Natural Rate of Unemployment (or by economics -> full-employment rate of unemployment)

When all workers who want jobs have them (apart from those who are frictionally and structurally unemployed) and the demand and supply of labor are in equilibrium. - Economists disagree on the exact value of the natural rate of unemployment, and there is good reason to believe that it varies over time in response to changes in the age and gender composition of the labor force and changes in government policies with respect to taxes, minimum wages, and unemployment insurance compensation.

more notes from the book as to how an OMPurchase increases interest rates:

a) (CHP4) The bond market model: the FED demanding more Treasury sec. causes for their prices to increase b) (CHP3) The reverse relationship btw bond prices and their yields: P increases therefore yield(or interest rate, i) decreases. c) (CHP14) OMPurchase => bank reserves increase | (increase)MB = C + R(increase) | (increase)MS = m + MB(increas) d) (CHP4) The Money Market Model: shows a graph with i as the y-axis and Q of Money as the x-axis; MS shifts to the right => observing a decrease in the interest rate e) (CHP5) (form structure of i) Short-term and long-term interest rates tend to move together => meaning since ST decreases then LT also decreases => therefore making people rely more => GDP(inc) = C(inc) + I(inc) + G + NX Everything good.

Secondary Credit

consists of discount loans to banks that are not eligible for primary credit. - because they have inadequate capital or low supervisory ratings. - used for banks that are suffering from severe liquidity problems, including those that may soon be closed. - the Fed carefully monitors how banks are using the funds they obtain from these loans. The secondary credit interest rate is set above the primary credit rate, usually by 0.50%. For instance, in September 2020, the primary credit rate was 0.25%, and the secondary credit rate was 0.75%.

Seasonal Credit

consists of temporary, short-term discount loans to smaller banks in areas where agriculture or tourism is important - For example, by using these loans, a bank in a ski resort area in Vermont won't have to maintain excess cash or sell loans and investments to meet the borrowing needs of local firms during the winter months. - The seasonal credit interest rate is tied to the average of rates on certificates of deposit and the federal funds rate. In September 2020, the seasonal credit rate was 0.10%. Because of improvements in credit markets that allow even small banks access to market loans, many economists question whether a seasonal credit facility is still needed.

Defensive open market operations (temporary in nature)

intended to offset temporary fluctuations in the demand or supply for reserves. Defensive open market purchase conducted through repurchase agreements a) With these agreements, the Fed buys securities from a primary dealer, and the dealer agrees to buy them back at a given price at a specified future date, usually within one week. In effect, the government securities serve as collateral for a short-term loan. Defensive open market sale conducted through reverse repurchase agreements (matched sale-purchase transactions) a) the Fed sells securities to primary dealers, and the dealers agree to sell them back to the Fed in the near future. - Economic disturbances, such as natural disasters, also cause unexpected fluctuations in the demand for currency and bank reserves. The Fed's account manager must respond to these events and sell or buy securities to maintain the monetary policy indicated by the FOMC's guidelines.

Discount Window

the means by which the FED makes discount loans to banks. this serves as the channel for meeting the liquidity needs of banks

Discount Policy

the policy tool of setting the discount rate and the terms of discount lending when Congress passed the Federal Reserve Act in 1913, it expected that discount policy would be the Fed's primary monetary policy tool.

The Fed's Monetary Policy Tools Over Time - Implementing Open Market Operations (part 1)

• The FOMC issues a policy directive to the Federal Reserve System's account manager, who is a vice president of the Federal Reserve Bank of New York and is responsible for implementing open market operations. • The Open Market Trading Desk is linked electronically through the Trading Room Automated Processing System (TRAPS) to 24 primary dealers (private securities firms, such as Goldman Sachs and Cantor Fitzgerald; FED selected). • Each morning, the trading desk notifies the primary dealers of the size of the open market purchase or sale and asks them to submit offers to buy or sell Treasury securities.

Open Market Operations Versus Other Policy Tools

• The benefits of open market operations include control, flexibility, and ease of implementation. (Because the Fed initiates open market purchases and sales, it completely controls their volume.) • Discount loans depend in part on the willingness of banks to request the loans and so are not as completely under the Fed's control. • The Fed can make both large and small open market operations. • Reversing open market operations is simple for the Fed. Discount loans and reserve requirement changes are more difficult to reverse quickly. (For example, if the Fed decides that its open market sales have made reserves grow too slowly, it can quickly authorize open market purchases.) • The Fed can implement its open market operations with no administrative delays. Changing the discount rate or reserve requirements requires lengthier deliberation.

Discount Lending During the Financial Crisis of 2007-2009 (section)

• The initial stages of the financial crisis involved shadow banks rather than commercial banks. • So, the Fed was handicapped in its role as a lender of last resort because it typically lends to banks. • But then the Fed used its authority to set up temporary lending facilities: 1. Primary Dealer Credit Facilities 2. Term Securities Lending Facilities 3. Commercial Paper Funding Facilities 4. Term Asset-Backed Securities Loan Facilities (TALF)

Economic Growth

an increase in the economy's output of goods and services over time. - Economic growth provides the only source of sustained real increases in household incomes. - Economic growth depends on high employment. - With high unemployment, businesses have unused productive capacity and are much less likely to invest in capital improvements. - Stable economic growth allows firms and households to plan accurately and encourages long-term investment.

Discount Lending During the 2020 Covid19 Pandemic (section)

Two categories of the lending facilities the Fed operated in 2020: 1. Liquidity facilities, which build on the Fed's original role as a lender of last resort 2. Credit facilities, which allow the Fed to provide funds directly to nonfinancial firms and state and local governments

How can monetary policy be effective? (from the book)

We've noted that to be effective, monetary policy needs to affect long-term interest rates, such as the interest rates on corporate bonds and on mortgages. Changes in long-term interest rates have a greater effect on the spending of households and firms than do changes in short-term interest rates because households and firms typically pay the long-term interest rate when they borrow to finance long-lived purchases such as houses and factories.

Facility

formal assistant program offered by the FED to a set oof targeted counter-parties with funding heads. (from professor)

Dynamic open market operations (permanent in nature)

intended to change monetary policy as directed by the FOMC. likely to be conducted as outright purchases and sales of Treasury securities to primary dealers

Effects of Open Market Purchase on the Federal Funds Market (lower the iff)

Suppose the Fed lowers the target for federal funds rate. • To achieve it, the Fed conducts open market purchase => give banks reserves => supply of reserves increases (shifts to the right) and iff decreases.

Effects of Open Market Sale on the Federal Funds Market (raise the iff)

Suppose the Fed lowers the target for federal funds rate. • To achieve it, the Fed conducts open market sale => take away banks reserves => supply of reserves decreases (shifts to the left) and iff increases

The Effect of Changes in the Discount Rate and in Reserve Requirements (section)

changes in discount rate changes in the required reserve ratio (rD)

Primary Credit

consists of discount loans available to healthy(solvent) banks experiencing temporary liquidity problems. - In that sense, primary credit represents the Fed's actions in its role as a lender of last resort. When economists and policymakers refer to the discount rate, they are referring to the interest rate on primary credit. - Banks may use primary credit for any purpose and do not have to seek funds from other sources before requesting a discount window loan from the primary credit facility, or standing lending facility. - The loans are usually very short term—often overnight—but they can be for as long as several weeks. - The primary credit interest rate is set above the federal funds rate, and so it is only a backup source of funds because healthy banks will choose to borrow at a lower interest rate in the federal funds market or from other sources.

Reserve Requirement (setting the rD)

is the regulation requiring banks to hold a fraction of checkable deposits as vault cash or deposits with the FED. Since 2008, banks have been holding far more reserves than necessary to meet the Fed's required reserve ratio, making reserve requirements no longer an important tool of monetary policy.

Practice Question 2 - Suppose the Bank of Japan's deposits at the Fed are expected to decrease permanently. Everything else held constant, the most appropriate action for the Fed to take to combat this situation would be a _____ open market _____ of bonds.

it is not defensive sale or purchase option A (based on elimination and deduction)

more info from the book about High Employment

the Fed attempts to reduce levels of cyclical unemployment, which is unemployment associated with business cycle recessions. Sometimes economists have difficulty distinguishing structural unemployment from cyclical unemployment. (cannot decrease the other 2 bc of external factors)

Regime after 2008 (banks had ample reserves and it introduces the upper limit or the iORB and the lower limit or the iONRRP)

the S curve (both segments) is now located further away from the D first segment (the shift caused the no independent effect on the iff) iORB sets the ceiling. iONRRP sets the floor. and increase in all 3 i causes for both the curves to incease or move up.

Effective Federal Funds Rate

the equilibrium rate in the federal funds market.

Federal Funds Rate

the interest rate that banks charge each other on very short-term loans. The target for the federal funds rate is set at FOMC(can't set the rate directly but through dealers) meetings. (8 times per year at DC) The Fed sets a target for the federal funds rate, but the actual rate is determined by the interaction of demand and supply for bank reserves in the federal funds market.

The Federal Funds Market

the market in which banks borrow and lend reserves to and from one another how the Fed uses its policy tools to influence the federal funds rate and the money supply.

The Fed's Dual Mandate

• How can the Fed pursue all six of its policy goals at once? In fact, all these policy goals are related to two broad goals: price stability and maximum employment. • If the Fed can attain these two goals, it will typically attain its other goals as well. • So, price stability and maximum employment are also known as the Fed's dual mandate. (When the U.S. economy experiences a period of price stability and high employment, it usually also experiences economic growth and stability of financial markets, interest rates, and foreign exchange rates.) • Whether the Fed's dual mandate is necessarily consistent with financial market stability is an open question.

The Fed's Monetary Policy Tools Over Time - Open Market Operations (primary tool before 2008; now just to keep the target stable)

• In 1935, Congress established the FOMC to guide open market operations because of the lack of coordinated intervention by the Fed during the banking crisis of the early 1930s. • An open market purchase of Treasury securities causes their prices to increase, and so their yield to decrease. As the monetary base increases, the money supply will expand. • An open market purchase is an expansionary policy(loose) because it reduces interest rates. • An open market sale has the opposite effects, and so it is called a contractionary(tight) policy.

New facilities the Fed established beginning in March 2020:

• Primary Dealer Credit Facility • Commercial Paper Funding Facility • Money Market Mutual Fund Credit Facility • Central Bank Liquidity Swap Lines • Facility for Foreign and International Monetary Authorities • Term Asset-Backed Securities Loan Facility (TALF) • Primary Market Corporate Credit Facility • Secondary Market Corporate Credit Facility • Municipal Liquidity Facility • Main Street New Loan Facility (MSNLF) • Main Street Expanded Loan Facility (MSELF)

Discount Policy (how has it changed over time?)

• Since 1980, all depository institutions have had access to the discount window. • Each Federal Reserve Bank maintains its own discount window, although all Reserve Banks charge the same discount rate.

Overnight reverse repurchase agreement (ON RRP) facility

- In 2015, the Fed raised the interest rate it offered on reverse repurchase agreements (also called matched sale-purchase agreements or reverse repos) (when a bank reserve account is not eligible to receive IORB) - This is an effective way for the Fed to achieve the target for the federal funds rate a) Especially when banks are holding very large levels of excess reserves. GOAL = the rate sets the floor for the federal funds rate (FFR)

Price Stability

- Inflation, or persistently rising prices, erodes the value of money as a medium of exchange and unit of account. - Problems caused by inflation: 1. Inflation makes prices less useful as signals for resource allocation. 2. Uncertain future prices complicate decisions households and firms have to make. 3. Inflation can also arbitrarily redistribute income. 4. Hyperinflation (inflation in the hundreds or thousands of percent per year) can severely damage an economy's productive capacity. (can destroy currency)

Supply of Reserves (from the book)

- The Fed supplies borrowed reserves, in the form of discount loans, and nonborrowed reserves, through open market operations. - During and after the financial crisis of 2007-2009 and again during the Covid-19 pandemic of 2020, the Fed greatly increased the supply of reserves through its purchases of Treasury bonds and mortgage-backed securities. - The vertical portion of the supply curve reflects the assumption that the Fed can set reserves, R, at whatever level it needs to meet its objectives. So, the quantity of reserves does not depend on the federal funds rate - At a federal funds rate below the discount rate, we assume that banks do not borrow from the Fed because they can borrow more cheaply from other banks. So, in this case, all bank reserves are nonborrowed reserves. - The discount rate is a ceiling on the federal funds rate because banks would not pay a higher interest rate to borrow from other banks than the discount rate they can pay to borrow from the Fed.

QE (part 2)

1. mainly used to target long-term interest rate 2. when FED buys a 10Y treasury notes that lowers the interest rate on it 3. moreover, because interest rates on both short and long-term move together the FED can lower the interest rate on the long-term. 4. as a result, this encourages an increase in consumption and investment (here she used the GDP formula from 201 = C + I + G + NX) increase in C and I causes for GDP to also increase which is good.

The figure on the slide summarizes the Fed's current procedures for increasing its target for the federal funds rate. (iONRRP increase)

A) when the interest rate on overnight repurchase agreements (iONRRP) is increased by the FMOC through policy tools - affects the following: 1. Certain non-bank financial institutions that can borrow and lend in the FFM but are not paid interest on their deposits with the FED (examples: Fannie Mae, Federal Home Loan Banks) - that keeps the FFR above the bottom of the target range and the FFR rises into the new target

The figure on the slide summarizes the Fed's current procedures for increasing its target for the federal funds rate. (iORB increase)

A) when the interest rate on reserve balances (iORB) is increased by the FMOC through policy tools - affects the following: 1. Depository institutions that can borrow and lend in the FFM and are paid interest on their deposits with the FED - that pushes the iff to the top of the target range and the FFR rises into the new target

Practice Question 1 - Suppose the Fed decides to decrease the required reserve ratio. If the Fed does not want this change to affect its target for federal funds rate, it should conduct an open market _______ of bonds, everything else held constant. If the Fed does nothing, however, the federal funds rate will______.

B (based on my deduction)

Explanation of the 4 box image in the slides:

BOX 1 states: FMOC sets FF target rate (through policy implementation) BOX 2 states: affects market interest rates and overall financial conditions BOX 3 states: influences consumers' and producers' spending decisions BOX 4 states: progress maximum employment and stable prices.

Term Securities Lending Facilities

Intended to allow financial firms to borrow against illiquid assets. - Under this facility, the Fed would loan up to $200 billion of Treasury securities in exchange for mortgage-backed securities. By early 2008, selling mortgage-backed securities had become difficult. - closed in 02/2010 after being established in 03/2008 (set amount of time to deal with financial crisis))

Primary Dealer Credit Facilities

Intended to allow investment banks and large securities firms to obtain emergency loans. - Under this facility, primary dealers could borrow overnight using mortgage-backed securities as collateral. - closed in 02/2010 after being established in 03/2008 (discount window)