Chapter 15 money and banking

Why is the function of the lender of last resort not superfluous (unnecessary)

-1% of total deposits held by banks, so if a large amount of banks fell simultaneously then the FDIC would not be able to cover all the depositors losses

Large Scale Asset Purchases

-The Fed started two new, large scale asset purchase programs to lower interest rates for particular types of credit -purchases mortgaged back securities -purchased long-term treasury securities -purchase of both

Open Market Operations impact on Federal Funds rate (New Answer)

-an open market purchase shifts supply to the right and causes the federal funds rate to fall, whereas an open market sale shifts supply to the left causes federal funds rate to rise -if supply curve initially intersects demand on its flat section, open market operations have no effect on iff New Answer: since the Fed normally sets the target for the Fed funds rate above the interest paid on reserves, an open market purchase, which would increase NBR, would shift supply to the right decreasing the fed funds rate, if supply and demand interesect on the flat section (this being the fed funds rate is equal to the interest paid on reserves than it will have no effect on the fed funds rate)...Vice versa for an open market sale

how would the fed lower the fed funds target rate

-an open market purchase would shift the supply of non borrowed reserves to the right, which would then increase the the fed funds rate

nonconventional monetary policy tools

-conventional can't do the job in full-scale financial crisis 1.financial system seizes up to such an extent that it becomes noble to allocate capital to productive uses, and so investment spending and the economy collapses 2. The negative shock to the economy can lead to the zero-lower-bound problem, in which the central bank is unable to lower short-term interest rates further because they have hit a floor of zero

Fed of lender of last resort to financial system as a whole

-discount window can help precent and address financial panics that are not triggered by bank failures

when will conventional monetary policy tools not work...why can't they do the job?

-full scale financial crisis 1. financial system seizes up so much that it is unable to allocate capital to productive uses, so investment spending and economy collapse 2. the zero-lower bound problem in which the central bank is unable to lower short-term interest rates further because they have hit a floor of zero (occurred in 08')

Secondary Credit

-given to banks that are in financial trouble and are experiencing sever liquidity problems. -the interest rate on secondary credit is set .5% above the discount rate -interest rate on these loans is set at a higher, penalty rate to reflect the less-sound condition of these borrowers

seasonal credit

-given to meet the needs of a limited number of small banks in vacation and agricultural areas that have a seasonal pattern of deposits -interest rate is average of federal funds rate and certificate of deposits -contemplating being eliminated

Increase in the demand for reserves

-if iff is below the discount rate, then leads to a rise -if it is at the discount rate then the fed funds rate will remain at the discount rate

Interest on Reserves on Federal Funds Rate

-if supply intersects demand at its downward sloping section, interest rate paid on reserves is raised, fed funds remains the same -if the supply curve intersects the demand curve on its flat section, a rise in in the interest rate on reserves raises the federal funds rate

liquidity provision

-increases in its lending facilities to provide liquidity to the financial markets 1. Discount Window Expansion -lowered the discount rate (interest rate on loans it makes to banks) to .5% above fed funds target (normal is 1%) -use of the discount window was limited during the crisis because the discount window has a "stigma" attached to it 2. Term auction Facility -set up Term Auction Facility (TAF) -more widely used than the discount window because it enabled banks to borrow at a rate lower than the discount rate, and the rate was determined competitively rather than being set at a penalty rate 3.New Lending Programs -Fed broadened its provision of liquidity to the financial system well beyond its traditional lending to banking institutions -lending to investment banks as well as lending to promote purchases of commercial paper, mortgaged backed securities and other asset backed securities

management of expectations (forward guidance)

-keep fed funds rate at zero for a long time -lower market expectations of future short-term rates, causing long-term to fall

Discount Lending impact on Federal Funds rate

-most changes in the discount rate have no effect on federal funds rate (when intersection is on vertical section) -if they interest on supply flat section, so that there is some discount lending, changes in the discount rate do affect the federal funds rate -when the discount rate is lowered, the federal funds rate falls

primary credit

-most important, healthy banks borrow all they want at very short maturities (overnight), and this is referred to as standing lending facility -interest rate on these loans is set 1% higher than the fed funds target because the Fed prefers that banks borrow from each other in the federal funds market so that they continually monitor each other for credit risk -the amount of discount lending under the primary credit is very small -this facility is the backup source of liquidity for sound banks so that fed funds rate rises to far above fed target set by FOMC -puts ceiling on the federal funds rate at the discount rate

interest on reserves tool

-not been used yet as a tool of monetary policy -used as a floor for monetary policy -if the fed funds rate is zero, then a rise in this would increase the fed funds rate

Interest on Reserves

-only started in 2008 -sets the interest rate on reserves below the fed funds target -it is a floor under the federal funds rate so this means it has not been used as a tool of monetary policy -the interest rate on reserves tool can come to the rescue because it can be used to raise the fed funds rate

primary dealers

-open market operations are conducted electronically through a specific set of dealers -

open market operations (conventional monetary policy tools)

-primary determinants of change in interest rates and the monetary base -open market purchases expand reserves and monetary base, thereby increasing money supply and lower short-term interest rates (vice versa with sales) -Fed conducts most of its open market operations in treasury securities because it is the most liquid market

effect of interest rate paid on reserves on federal funds rate

-sets a floor for the federal funds rate

why does the Fed set the target below the discount rate

-so that banks can monitor each other

supply curve for reserves

-supply curve is NBR and BR -if iff is below the discount rate, then banks will not borrow from the Fed (borrowed reserves will be zero) -as long as iff is below id, then the amount of reserves supplied will equal NBR -if the fed funds rate begins to rise above the discount rate, people will borrow more at id

effect of an expectation of a huge withdrawal on the fed funds rate, borrowed reserves, and non-borrowed reserves

-the fed will want to increase their excess reserves, meaning the demand for reserves will increase, if the iff is below the discount rate, then the fed funds rate will increase

what is the opportunity cost of holding excess reserves...what is the benefit of holding excess reserves

-the interest rate that could have been earning on lending these reserves out minus the interest rate that is earned on the reserves (paid by the Fed) -excess are insurance against deposit outflows;

Lender of last resort

-to prevent bank failures from spinning out of control, Fed provides reserves when no one else would -makes banks take on more risk -created a moral hazard problem ; banks take on more risk, exposing the deposit insurance agency, and hence taxpayers, to greater losses. -moral hazard is most severe for big banks which may believe that the Fed feels they are too big too fail because the Fed will always come to their rescue

reserve requirements on federal funds rate

-when the Fed raises reserves requirements, the demand increases and the federal funds rate rises -decline in required reserve ratio lowers the quantity of reserves demanded, and the federal funds rate falls

relative advantages open market operations over other tools

1. complete control over volume (in discount operations they can only encourage or discourage banks of borrowing reserves) 2. flexible and precise;used to the exact extent desired 3.easily reversed 4. implemented quickly; no administrative delays

two situations in which other tools have advantages

1.when the Fed wants to rise interest rates after banks have accumulated large amount of excess reserves -in this case, the fed funds rate can be raised by increasing the interest on reserves which eliminates the need to conduct massive open market operations to raise the fed funds rate by reducing reserves 2. when discount policy can be used by the Fed to perform its role as lender of last resort

changes in the tools of monetary policy affect the Federal Funds Rate

Open Market Operations Discount Lending Reserve Requirements Interest on Reserves

two types of commitments to future policy actions

conditional -stated that the decision was predicated on a weak economy going forward unconditional -not indicating that his decision might change depending on the stare of the economy

demand curve for market for reserves

if the fed funds rate is above the interest paid on reserves (like it normally is), as the federal funds rate decreases, opportunity cost falls, and the demand for reserves rises (this is because banks want more reserves if they are not getting as much interest) -when the fed funds rate begins to fall below the interest paid on reserves, banks do not lend in the overnight market, so the demand for excess reserves increases and demand becomes (infinitely elastic)

zero-lower-bound problem

in which the central bank is unable to lower short-term interest rates further because they have hit a floor of zero

federal funds rate....when is it announced...is it the primary monetary policy?

interest rate on overnight loans of reserves from one bank to another -announced at each FOMC meeting -primary instrument of monetary policy

Federal Reserves' operation procedure

limits the fluctuations of the federal funds rate so that it remains between the interest rate paid on reserves and the interest rate charged by Fed on loans (discount rate)

non conventional tools

liquidity provision -discount window expansion -term auction facility -new lending programs Large-Scale Asset Purchases Quantitative Easing Versus Credit Easing Forward Guidance and the Commitment to Future Policy Actions

conventional monetary policy tools

open market operations discount lending reserve requirements

Fed's discount loans to banks

primary credit, secondary credit, seasonal credit

quantitative easing versus credit easing

quantitative easing -expansion of the balance sheet -leads to a huge increase in monetary base -stimulate economy in near term and produce inflation down the road-did not result in large increase in money supply

Defensive open market operations

repurchase agreement (repo) -fed purchases securities with an agreement that the seller will repurchase them in a short period of time, anywhere from one to fifteen days from the original date of purchase -repo is temporary (reversed when repurchased by seller) Matched sale-purchase transaction (reverse repo) -Fed sells securities and the buyer agrees to sell them back to the Fed in the near future

effect of a decrease in reserve requirements on the fed funds rate, borrowed reserves, and non-borrowed reserves

shifts the demand for reserves to the left, at any given interest rate, the fed funds rate decreases, and NBR and BR remain unchanged

Discount Window

--the facility at which banks can borrow reserves from the Federal Reserve

effect of an increase in deposits on the fed funds rate, borrowed reserves, and non-borrowed reserves

a rise in checkable deposits leads to a rise in required reserves, quantity demanded of reserves increases - if iff is below the discount rate, (which it normally is), this will lead to a rise in fed funds rate (know from previous card)

credit easing

altering the composition of the Fed's balance sheet in order to improve the functioning of particular segments of the credit markets

two categories of open market operations

dynamic Open market operations -intended to change the level of reserves and MB defensive open market operations -intended to offset movements that affect reserves and MB

standing lending facility

healthy banks borrow all they want at very short maturities (overnight)

what happens if the Fed raises the ior above the equilibrium funds rate

the floor of reserve demand will push the equilibrium fed funds rate along with the interest rate on reserves. both borrow reserves and non-borrowed reserves will remain the same

how does the fed raise the target rate

they will have to conduct an open market sale of securities, which will shift the supply of non-borrowed reserves to the left, the fed funds rate will increase, borrow reserves will remain the same