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