Global Monetary Policy and Central Banks

Velocity of money(turnover rate of money) =

(Price level x transactions) / money supply

Financial accelerator

A negative shock to the economy may be intensified by worsening financial market conditions

The ECB uses tenders, which is

A type of loan to, to inject or withdrawal liquidity from money markets

How does the federal funds rate decrease with expansionary OMO?

Bank's like chase have excess reserves, will lend at the fed funds rate to other banks that have lacking reserves, this increases the money supply

Unilateral intervention and concerted intervention

Both aimed at keeping the euro stable Buy and sell euros on its own Buy and sell euros as part of a coordinated effort w/ other Cbs

Who makes changes in monetary policy

Central banks Bank of England Federal Reserve European central bank

Monetary Policy

Changes in money supply or interest rates to impact the overall economy

Why is controlling interest rates hard when you are using the money supply?

Controlling IR by controlling the MS is hard because money demand is not stable, it requires nimble control the increase decrease of money supply

Why is controlling the money supply hard when you have unstable money demand?

Controlling the money supply leads to unstable interest rates. If you have unstable money demand, and a money supply held constant by the fed, it will cause constantly changing IR, makes capital budgeting decisions very hard.

Contractionary monetary policy:

Decreases in money supply and/or increases in IR to fight inflation

Liquidity Trap

Expansionary monetary policy fails to stimulate overall economy because of a high level of of savings and lack of borrowing in financial markets. When the economy is already liquid, injecting more liquidity will not help The economy slows not because of liquidity (it is swimming in cash) but because of a lack of spending

ECB Structure

Headed by president and VP, elected by governments of countries that use the eruo 3 governing bodies: Governing council -Executive board + governors "heads" of CBs -Monetary policy, bank note issuance, managment of reserves and fx operations General council -Transitional issues of countries who wish to begin using the euro Executive board -Implements monetary policy decisions made by governing council -President, VP, 4 outside monetary policy experts

Expansionary monetary policy:

Increases in the money supply and/or cuts in the IR to fight economic slowdowns

Keyne's theory of demand for money is called

Liquidity Preference Theory

Are central banks controlled by the government?

No, they are not part of or controlled by government. May answer to the government, but it is not governments that control monetary policy. They are independent of the political process

Should monetary policy be used to end asset bubbles?

No. Should use policy to clean up after asset bubble pops.

3 ECB Tools

OMO Standing lending facilities Minimum reserve requirements

What 3 areas does the governors work focus on

Operations of the Fed's 12 banks Commercial Bank Regulation Monetary Policy

Bank of england is accountable to

The parliament It is politically independent though

Asset bubbles

When the bubble is growing, resources are mis-allocated. So much labor is diverted into the wrong market. Harder for companies to get capital. "Greater fool theory" people will buy an asset simply because the price of the asset had increased in the past. Biggest problem is when they pop. Wealth is destroyed quickly, uncertainty overtakes markets and entire economy can suffer So many CB argue that monetary policy cannot and should not be used to end asset bubbles

ECB standing facilities

aka lending facilities Has 2 Designed to inject or absorb funds in the overnight lending market in order to help stabilize bank to bank lending

The bank of england is the bank for

all of the UK

When the fed began operation, it was a collection of 12 banks whose purpose was to

maintain the gold standard and be a "lender of last resort" to commercial banks.

Discount rate

the interest rate that the federal reserve charges on loans it makes to member banks. These discount loans are made at the Fed's discount window

From 2010-2013 what asset greatly increased on the fed's balance sheet and why

their holding of securities, because they purchased many mortgage-backed securities in attempt to stabilize the market

QE3

Extraordinary expansionary monetary policy New bond buying program to reduce *elevated unemployment rate* Announces a tapering of policies

Reverse repo

Fed borrows money from primary dealers w/ agreement to buy it back Impact is to withdraw reserves from the banking system Used to make short term adjustments int he level of liquidity in the banking system

Expansionary OMO

Fed buys up government securities from the public

Responsibilities of the Fed -Financial market oversight -Fiscal Agent of the Treasury -Consumer Protection -Dissemination of Economic Information

Financial market oversight: -Supervising/regulating different financial market entities -Bank examination/regulation -Review bank m&a Fiscal Agent of the Treasury: -Serve as the fiscal agents and depositories of the US gov -Revenue collection, debt issuance, maintenance of the gov checking account Consumer Protection: -Writing and enforcing financial market regulations to implement many of the consumer protection laws passed by congress -Congressed passed truth in lending act: requires lenders to state clearly key terms of the lending agreement and fully disclose all costs. *Fed created Regulation Z to implement this act. lays out specifically what info about terms and costs of credit as apply to mortgages, credit cards, and other credit needs* -Criticized by E. Warren, who believes that they serve bank needs over consumers, criticizes housing CFPA within the fed Dissemination of Economic Information: - Produce reports on the economy in their regions that are free for the public

What exactly should the central banks target

Low IR Money Supply Inflationary expectations Asset bubbles

Low IR

Low IR: If goal is low IR, they use expansionary monetary policy, causes the money supply to increase, which can lead to an increasing rate of inflation, and through the fisher effect will lead to higher market IR. So, ends up going against goal.

ECB's 4 tools within OMO's

Main refinancing operations longer-term refinancing fine-tuning operations that provide structural liquidity

String anaology

Monetary policy is like a string: You can pull on a string (contractionary monetary policy works to slow an economy down) but you cannot push on a string (expansionary monetary policy is not effective in getting the economy out of a slump)

Total output =

Money Supply x Velocity Price level x amount of transactions

Are open market operations done in the primary or secondary market?

Secondary. The fed is not buying and selling government securities directly from the government, but from or to a private entity

The structure of the fed was dramatically altered in response to

The Great Depression. Banking Act of 1935 brought major changes in the structural makeup Consolidated the power of the Fed into the board of governors and reduced the influence of the regional Fed banks Made the fed more independent from the government

Blue book

compiled by BOG staff, contains a discussion of *policy options faced by the FOMC*

If the fed increases the required reserve ratio, banks would be required to

hold more reserves, and thus decrease the size o the money multiplier

Changes in the required reserve ratio affect the

money multiplier

Quantitative easing

monthly purchases of gov and mortgage backed securities 2014 Fed announced itw as going to taper (gradually reduce) this program

When the Fed purchased 100 billion in debt from Freddie Mac and Fannie mae, their goal was

not to reduce interest rates (as done typically with expansionary OMO) but to inject liquidity into the markets

Greater fool theory

people will buy an asset simply because the price of the asset had increased in the past.

Contractionary OMO Transactions (5 million)

$5 million in government securities goes from the Fed to Mr. Beans. The Fed pulls $5 million out of Citibank's member bank reserves account at the Fed. Citibank sees its cash/reserve account (which includes the deposits it has at the Fed) decrease by $5 million. Citibank debits or reduces Mr. Beans's demand deposit by $5 million and thus Mr. Beans sees his demand deposit balance decrease by $5 millio

Why is the required reserve ratio rarely used for monetary policy?

1) Sweep accounts: bank customer's balance above a certain amount are swept out of a checking account by the bank and put into an overnight account that pays interest With sweeping accounts, checking accounts have significantly lower "balances" against which deposits must be held 2) Rise of ATMs: Cash in ATMs is counted as vault cash and may be counted as required reserves held by banks. So as ATMs grew, amount of reserves held by banks increased If banks already hold more than what is required, then cutting the required reserve ratio will not have any impact on the amount of bank lending.

QE2

2nd round Extraordinary expansionary monetary policy Operation Twist: twist the yield curve by purchasing by pushing yields on long term securities downward

How many governors are there

6, in addition to the chair

Argument against an in favor of central banks being independent of the political process

Against: independence of CB is "undemocratic" In favor: Some policies that are needed may be unpopular. Elected officials only care about being re-elected so will only focus on short term solutions (short term solutions causes more policies that lead to economy over heating, and more so, inflation)

Currency outstanding

Amount of federal reserve notes (paper currency) held by the public and the banking system

How is the president of the fed appointed?

Appointed by the president and confirmed by the US senate to a 4 year renewable term. No other qualifications at all- no required background in finance or econ

How are the governors appointed and how long are their terms

Appointed in the same way as the president/chair 14 year non renewable terms

2007-2009 Great Recession

Asset bubble: irrational increase in the mv price of an asset Housing bubble deflates, prices of houses fall Number of mortgage defaults increases substantially (market is filled with uncertainty as to who has exposure and how much exposure to these non-performing mortgages) Banks have trouble figuring out their exposure (how many slices of mad mortgages do we have?) This makes them stop lending to consumers AND other banks Fed funds market dries up: this is a major problem Fed's major tool OMO is useless since the fed funds market is dried up Fed needs to find a new tool for injecting funds and reserves Bank's don't want to borrow from the Fed with a fear of hurting their reputation New tools: emergency lending programs (like term auction facility) and quantitative easing

Fed's response to 2007 by looking @ balance sheet

Asset side: Bought up mortgage backed securities Created term auction facility and commercial paper fund to plump up liquidity Created Maiden Lanes and other LLC's to deal w/ financial market meltdowns Liability side: Depository institutions were holding on to large amounts of reserves, sitting on their cash and not lending Treasury deposits swelled up in response to changes on the asset side

Green book

BOG staff of economists complies the green book, which is the staff's *economic forecast on where the economy and financial markets are headed over the next few months/years*

Open Market Operations (OMO)

Buying and selling of government securities in the secondary market in order to influence bank reserves, and thus the money supply and/or interest rates Can really use any asset but do government bods and securities because they are easy to price and have no default risk

Real bills doctrine

CB should lend money to commercial banks if and only if the commercial banks use those funds to support "real" as opposed to speculative economic activity These real bills would, in theory, include loans to entities that would use loan proceeds only to produce goods and services, not for speculation. T

3 main benefits of TAF over discount window lending

Control: Allowed Fed to control exactly how much liquidity was pumped into the system. B/c these reserves are delivered within 3 days (unlike day of discount window lending) fed has more control No more stigma: banks "borrow as one" Wide dispersion: Fed limits the amount any one bank can borrow to 10% of the auction, so it ensures a large number of people benefit

Federal Open Market Committee (FOMC)

Created by The Banking Act of 1935 Committee within the Fed that is responsible for setting monetary policy Most powerful policymaking committee within the Fed and perhaps entire country

Beiege book

Document created eight times a year (for each FOMC meeting) by the staff of the BOG that describes the *current status of the business conditions and of the US economy as a whole*

Dynamic transactions vs defensive transactions

Dynamic Transactions: OMO designed to change the level of reserves Defensive transactions: OMO designed to maintain the level of reserves

Contractionary OMO

Fed sells government securities in secondary market to the public, to reduce bank reserves, leading to a decrease in the money supply, increasing interest rates

For Expansionary OMO, Assets & Liabilities of: Fed Bank Indv. Selling Securities

Fed: -Assets: Securities increases 100m -Liabilities: Member Bank Reserves increase 100m Chase Bank: -Assets: Cash Reserves increase 100m -Liabilities: Smith checking account increases 100m Mr. Smith -Assets: Securities decrease 100 million -Checking account increases 100 million Chase has more reserves, will now lend these reserves, which increases the money supply!

One area of overlap between the board of governors and the Fed Reserve District Bank is

Federal Open Market Committee (responsible for over-seeing the conduct of monetary policy) 12 voting members= 7 governors + 5/12 reserve bank presidents. 1 of the 5 is always NY, the other 4 slots rotate

Repurchase Agreement

Financial transaction where a primary dealer sells a security to the Fed with an agreement to buy it back at a set date in the future

QE1

First round of quantitative easing Purchase direct debt from Fannie Mae and Freddie Mac, and 750m in mortgage backed securities. Announces it will buy 300b in LT treasury bonds

Secondary Credit

Form of discount window lending Banks suffering from financial difficulty can borrow from the fed, but must pay a penalty interest above the discount rate

Seasonal Credit

Form of discount window lending Credit given to a limited number of banks that experience unusually high swings in their levels of reserves during different seasons of the year

Primary Credit

Form of discount window lending. Healthy banks are allowed to borrow from Fed Reserve for short periods of time, historically overnight

Inflationary expectations

Get financial markets to believe the central bank will control inflation, will help actually control inflation (fisher effect)

Bank of Canada

Governing council meets on a unanimous or consensus basis 2 major goals: flexible exchange rates and inflation control During the crisis of 2007, Canadian economies did much better than most advanced economies/ was concluded it was due to their strong approach to risk managment

Even if the required reserve ratio was binding, changes in it could cause more problems than they are worth.

If the Fed significantly changes the required reserve ratio, banks would be required to change their levels of liquidity in a significant way. These changes in liquidity could then affect other financial markets,

Federal Fund Rate

Interest rate that banks charge on loans to each other -Market determined -Fed reserve targets this rate (sets a target for it)

Responsibilities of the Bank of Japan

Issuing bank notes: -Disseminating country's currency and coins -Gaurds against counterfeitng Financial market stability: -Off-site monitoring: watches funding and investment policies, liquidity position, profitability -In-site monitoring: Visit depository institutions to determine safe-ness. Contingency plans: what bank will do in event of natural disaster or market crash. -Lendor of last resort *Monetary Policy: -Only pursues a single goal: price level stability*

2 primary responsibilites of the bank of england

Monetary Stability: Stable prices and confidence in the British Pound. Inflation target of 2%. If fails to meet this, must explain in an open letter to government's chancelor Financial Stability: -Financial services act ended triparte system and changed it to two entities: financial conduct authority (protect consumers) and prudent regulatory authority (regulate financial institutions) -Made bank of england main regulator of british financial markets

While crowding out is a bad effect of government budget deficits, what is another?

Monetization of public debt: Governments require commercial banks and/or central banks to purchase government bonds This essentially forces the banking system to create money for the government to spend (government debt is turned into money)

Is velocity of money constant?

No, it drops considerably during economic slowdowns

Is the New York fed all powerful?

No, it has the most power and influence compared to the 11 others, but it is not all powerful

Credit crunch

Reduction in the general availability of credit (lending) in financial markets seen as an irrational increase in aversion Lack of lending

For defensive transactions, trades make 2 types of transactions

Repos: Buys from primary dealer w an agreement to buy back at some point in the future *Add reserves to banking system* Matched sale-purchases (reverse repo): Fed sells government securities to a dealer or CB of another country with the agreement to purchase the security back within a short period of time *Take reserves from banking system* These reserves are just temporary because they are re-purchased or re sold in a few days, so it is used for defensive moves

Fed's response to the credit crunch during the financial crisis

Term Auction Facility: a combination of OMO and discount window lending Anonymously auction short term loans to financial institutions to get around the stigma affect Min interest rate bid is designed to be very close to market interest rates (so the TAF wasn't a penalty interest rate) Everyone who wins the auction pays the same price

Other forms of emergency lending

Term Securities Lending Facility Primary Dealer Credit Facility (fed lends money overnight to securities dealers who pledge acceptable collateral - investment grade securities. Essentially discount window for investment banks) Asset Backed Commercial Paper Money Market Investor Funding Facility Term Asset-Backed Securities Loan (focuses on securities backed by recently issued auto loans, credit card loans, student loans, small business loans, etc)

For a contractionary OMO, Assets and Liabilities of: -The Fed -Wells Fargo - Mrs. Jones

The Fed: -Assets: Government securities decrease 50m -Liabilities: Member bank reserves decrease 50m Wells Fargo: -Assets: Cash Reserves decrease 50 m -Liabilities: Checking account decrease 50m Mrs. Jones: -Assets: Government securities increase 50 m, checking account decreases 50 m

Quantity theory of money

The concept that the quantity of money is directly proportional to the price level Fisher argued people held money purely for transactions

How do open market operations work in reality?

They are undertaken by the open market trading desk at the Fed Reserve bank of NY, oversees the trading desk activities Sells and buys from "primary dealers" done electronically through TRAPS

Why does Greenspan think that asset bubbles are different from inflation?

They do not reflect changes in prices in overall economy, but just one market Monetary policy is too blunt, would effect everything and not just the irrationally increasing prices

Keyne's 3 motives for people to hold on to money (Liquidity Preference Theory)

Transactional Demand -Demand for money increases as income increases because people will spend part of their additional income in transactions Precautionary Demand for Money -During times of uncertainty, people want to hold on to money as oppossed to fincancial assets, because money is more liquid. Speculative Demand for Money -If you think IR will rise in the future, you will hold on to your money, to protect the total value of your wealth, and buy bonds when bond prices decrease.

Fed funds market, with a contractionary OMO, means fewer reserves in the banking system

this increases the federal funds rate Higher borrowing costs to banks are spread to customers, banks will charge a higher interest rate to maintain a interest rate spread, so market interest rates increase