econ ch 15

during the financial crisis, the Fed introduced 3 new policy tools that were still being used in 2017:

1. interest on reserve balances 2. overnight reverse repurchase agreement facility 3. Term deposit facility

The Fed has used three criteria when evaluating potential variables for policy instruments:

1. measurable 2. controllable 3. predictable

the Fed's 3 traditional policy tools

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

traditionally the Fed has relied on 2 types of targets: *Although using these targets is no longer the favored approach at the Fed, they provide some insight into the difficulties the Fed faces in executing monetary policy.

1. policy instruments (or operating targets) 2. intermediate targets

the fed's 6 monetary policy goals

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

Both tools are needed because of two distinct groups of financial institutions:

1.Depository institutions that are eligible to borrow and lend in the federal funds market, and whose deposits with the Fed receive interest 2.Financial institutions that are eligible to borrow and lend in the federal funds market, but whose deposits with the Fed do not receive interest

On December 16, 2015, the Fed raised the target for the federal funds rate from 0.25% to 0.50% by two new monetary policy tools:

1.Set the interest rate it pays on excess reserves (IOER) at 0.5% 2.Set the interest rate it pays on overnight reverse repurchase agreements (ON RRP) at 0.25%

Congress enacted the Employment Act of _________ and the Full Employment and Balanced Growth Act of __________ (the Humphrey-Hawkins Act) to promote high employment and price stability.

1946, 1978

Prior to _________, strong evidence supports the link between money and prices in the short run of a year or two. The economists who argued this point most forcefully were known as _________________, notably Nobel laureate Milton Friedman.

1980 monetarists

most economists est. that the natural unemployment rate is about _____%

5%

the target for the FFR is set at __________ meetings

FOMC

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), in which the Fed sell a security to a financial firm while at the same time promising to buy the security back the next day. This is an effective way for the Fed to achieve the target for the federal funds rate when banks are holding very large levels of excess reserves.

•In September 2011, the Fed announced its policy of _______________ __________, which involved buying $400 billion of long-term securities (lowering long-term interest rates) while selling $400 billion of short-term securities (raising short-term interest rates).

Operation Twist

•______________ economic growth allows firms and households to plan accurately and encourages long-term investment.

Stable

commercial Paper Funding Facility

The Fed purchased three-month commercial paper directly from corporations so they could continue normal operations.

Term Asset-Backed Securities Loan Facility (TALF)

The New York Fed extended three-year or five-year loans to help investors fund the purchase of asset-backed securities.

what actions can the Fed take to deflate an identified bubble without harming the financial system or the economy?

Traditionally, Fed policymakers have been reluctant to raise interest rates to head off potential asset bubbles. Former Fed Chairman Ben Bernanke argued that regulation and supervision of financial firms can do a better job.

Problems caused by inflation

a. inflation makes prices less useful as signals for resource allocation b. uncertain future prices complicate decisions households and firms have to make c. inflation can also arbitrarily redistribute income d. hyperinflation can severely damage an economy's productive capacity

The Fed establishes goals, but it directly controls only its policy tools. So it can use targets to help __________ monetary policy goals. in recent years, the Fed has deemphasized the use of targeting procedures of this type.

achieve

economic growth

an increase in the economy's output of goods and services over time

the Fed attempts to reduce cyclical unemployment associated with _______________ _____________ recessions

business cycle

interest rate on reserve balances

by raising the interest rate it pays, the Fed can increase banks' holdings of reserves, potentially increasing the money supply by reducing the interest rate, the Fed can have the opposite effect

Dynamic open market operations are intended to... •likely to be conducted as outright purchases and sales of Treasury securities to primary dealers

change monetary policy as directed by the FOMC.

After 1980, the short-run link between the growth of the money supply and inflation broke down because the nature of M1 and M2 had ___________________.

changed

primary credit

consists of discount loans available to healthy banks experiencing temporary liquidity problems.

secondary credit

consists of discount loans to banks that are not eligible for primary credit.

seasonal credit

consists of discount loans to smaller banks in areas where agriculture or tourism is important.

an open market sale raises/increases interest rate and therefore is called a _______________________ policy

contractionary

•The benefits of open market operations include ____________, ____________, and ________ ____ _________________

control, flexibility, ease of implementation.

•Some economists believe that actions to deflate asset bubbles may be __________________________________, but the severity of the 2007-2009 recession has made financial stability a more important Fed policy goal.

counterproductive

the FFR is determined by the ___________ and the ______________ for reserves in the federal funds market

demand, supply

the FFR is influences by the ______________ for and the ___________ of reserves

demand, supply

•The tools of monetary policy don't allow the Fed to have ___________ control over real output or the price level.

direct

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

discount window

Price stability and maximum employment are also known as the Fed's ____________ mandate. •Whether the Fed's dual mandate is necessarily consistent with financial market stability is an open question.

dual

•The stability of financial markets and institutions makes possible the _______________ matching of savers and borrowers.

efficient

an open market purchase is an ___________________ policy because it reduces interest rate

expansionary

•Examples of policy instruments are the ____________ ___________ __________ and _____________________ _______________.

federal funds rate, nonborrowed reserves

•Economic disturbances, such as natural disasters, also cause unexpected ___________________ 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.

fluctuations

•Even under the best economic conditions, some ________________ and _____________________ unemployment remain. The tools of monetary policy are ineffective in reducing these types of unemployment.

frictional, structural

•Economic growth depends on ____________ employment.

high

To fight bubbles, the Fed would first need to _____________ them, which are only clear in hindsight, but not as the bubbles develop.

identify

an open market purchase of Treasury securities causes their prices to _____________, and so their yield to decrease.

increase

Economic growth provides the only source of sustained real _____________________ in household incomes

increases

Term Securities Lending Facility

intended to allow financial firms to borrow against illiquid assets.

Primary dealer credit facility

intended to allow investment banks and large securities firms to obtain emergency loans.

•The Fed can make both _________ and ___________ open market operations. Often, dynamic operations require large purchases or sales whereas defensive operations call for small.

large, small

•With high unemployment, businesses have unused productive capacity and are much ___________ likely to invest in capital improvements.

less

•When financial markets and institutions are not efficient in matching savers and borrowers, the economy _______________ resources.

loses

•To spur economic growth, the Fed could ____________ the target for the federal funds rate, which increase the money supply, potentially increasing the inflation rate in the longer run.

lower

•For defensive open market sales, the trading desk often engages in ___________ __________-_____________ transactions (sometimes called reverse repos), in which the Fed sells securities to primary dealers, and the dealers agree to sell them back to the Fed in the near future.

matched sale-purchase

intermediate target e.g.'s

monetary aggregates, interest rates

high employment (low unemployment rate) is another key _______________ _____________ goal

monetary policy

When all workers who want jobs have them and the demand and supply of labor are in equilibrium, economists say that unemployment is at its __________________ _________

natural rate (or full-employment rate of unemployment)

Under Paul Volcker, the Fed shifted its policy to emphasize ______________________ __________________ as a policy instrument. This episode of "The Great Monetarist Experiment" produced mixed results.

nonborrowed reserves

Defensive open market operations are intended to... •much more common, and are conducted through repurchase agreements •a similar action is changing Federal Reserve float, which increases if there is a delay in check clearing after, e.g., transportation is delayed by a snowstorm

offset temporary fluctuations in the demand or supply for reserves, not to carry out changes in monetary policy.

the traditional assumption of scarce reserves

on a typical day, there are many banks that meet their need for reserves by borrowing from other banks in the Federal Funds Market

in 1935, congress est. the FOMC to guide ___________ _________________ _____________________

open market operations

policy tools e.g.'s

open market operations, discount policy, reserve requirements, interest rate on reserves, interest rate on overnight reverse repos

monetary policy goals

output, inflation, unemployment rate

•The Fed can use an intermediate target to achieve a goal ______________ of its direct control better than it would if it had focused solely on the goal. intermediate targest can also provide helpful feedback about the Fed's policy actions.

outside

changes in the discount rate since 2003, the Fed has kept the discount rate higher than the target for the FFR. so, the discount rate is a ______________ _______, as banks pay a penalty by borrowing from the Fed rather than from other banks

penalty rate

•The FOMC issues a ____________ _______________ to the Federal Reserve System's account manager, who is a vice president of the Federal Reserve Bank of New York.

policy directive

•Most major central banks use interest rates as _______________ _________________

policy instruments

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 __________________ pressure and a desire for a ___________ financial environment. •Sharp interest rate fluctuations cause problems for financial institutions. So, stabilizing interest rates can help to stabilize the financial system.

political, stable

The Fed's Dual Mandate •In fact, all these policy goals are related to two broad goals: __________ ___________ and ______________ __________________. •If the Fed can attain these two goals, it will typically attain its other goals as well.

price stability, maximum employment

Categories of Discount Loans

primary credit, secondary credit, and seasonal credit

•Each morning, the trading desk notifies the _______________ ____________ of the size of the open market purchase or sale and asks them to submit offers to buy or sell Treasury securities.primary dealers 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.

primary dealers

•The Open Market Trading Desk is linked electronically through the Trading Room Automated Processing System (TRAPS) to 23 ____________ _____________.

primary dealers

In the United States, the money supply has grown more ______________ during decades when the inflation rate has been relatively high.

rapidly

unemployment ________________ output and causes financial and personal distress

reduces

an open market sale of securities by the Fed ______________ reserves, shifting the supply curve to the _________. the equilibrium level of reserves ______________ while the equilibrium FFR ______________. the discount rate is also __________________.

reduces, left, decreases, rises, increased

The main policy instruments have been _________________ _________________ and the federal funds rate.

reserve aggregates

policy instrument e.g.'s

reserves, FFR

open market purchase of securities by the Fed shifts the supply curve to the __________. Then, the equilibrium level of reserves ________________ while the equilibrium FFR ________. the discount rate is also ______.

right, increases, falls, cut

an increase in the RR ratio shifts the demand curve for reserves to the __________. the equilibrium FFR ________. if the Fed offsets the effects of the increase in the RR ratio w/ an open market purchase, this shifts the supply curve to the ____________. then, the level of reserves _________________ while the target FFR remains unchanged..

right, rises. right, increases

The mortgage rate and the corporate bond interest rates generally __________ and ___________ with the federal funds rate.

rise and fall

The initial stages of the financial crisis involved ___________ __________ 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:

shadow banks Primary dealer credit facility, Term securities lending facility, Commercial Paper Funding Facility, Term Asset-Backed Securities Loan Facility (TALF)

Term Deposit Facility

similar to certificates of deposit (CD), 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'll have available to expand loans and the $ supply

•Reversing open market operations is ____________ for the Fed. Discount loans and reserve requirement changes are more ______________ to reverse quickly. •The Fed can implement its open market operations with _______ administrative delays. Changing the discount rate or reserve requirements requires _____________ deliberation.

simple, difficult, no, lengthier

Foreign-Exchange Market Stability •In the global economy, stability in the foreign-exchange value of the dollar is an important monetary policy goal of the Fed. •A stable dollar ________________ planning for commercial and financial transactions. •Fluctuations in the dollar's value change the international competitiveness of U.S. industry: e.g., 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.

simplifies

One possible solution to those timing problems is for the Fed to use _____________ to meet its goals. For example, some economists argue that an information lag resulted in the Fed reducing the target for the federal funds too slowly during 2006 and 2007 following the collapse of the housing bubble.

targets

supply of reserves is controlled by ______ __________

the Fed

the information lag refers to

the Fed's inability to observe instantaneously changes in economic variables.

open market operations

the Fed's purchases and sales of securities, usually U.S. Treasury securities, in financial markets

Demand for reserves is determined by

the banking system

quantitative easing

the central bank policy that attempts to stimulate the economy by buying long-term securities

The Fed also faces timing difficulties:

the information lag the impact lag

Federal Funds rate

the interest rate that banks charge each other on very short-term loans

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

reserve requirement

the regulation requiring banks to hold a fraction of checkable deposits as vault cash or deposits with the Fed

the impact lag is

the time that is required for monetary policy changes to affect output, employment, or inflation

•The Fed often faces ________-______ in attempting to reach its goals, particularly the goals of high economic growth and low inflation.

trade-offs

facts: The bursting of the dot-com bubble contributed to the 2001 recession, and the bursting of the housing bubble was a key factor in causing the severity of the 2007-2009 financial crisis and recession.

true

t/f Inflation erodes the value of money as a medium of exchange and as a unit of account.

true

changes in the required reserve ratio the Fed rarely changes the RR ratio. this action will likely carry out offsetting open market operations to keep the target for the FFR ___________________

unchanged

targets

variables that the Fed can influence directly and that help achieve monetary policy goals

Policy Instruments, or Operating Targets

variables that the Fed controls directly and they are closely related to intermediate targets.

•Discount loans depend in part on the ________________ of banks to request the loans and so are not as completely under the Fed's control.

willingness