Econ 104: Monetary Policy
What is the current monetary policy framework?
-Although the quantity of excess reserves has been declining since its peak in 2014, reserve balances are currently far in excess of banks' reserve requirements and the FOMC has indicated that it will in the longer-run conduct policy with ample reserves. -The Fed uses its newer tools—IOER and the ON RRP facility—to influence the FRR and short-term interest rates more generally.
How did the Fed ease the 2007 recession?
-By December 2008, the Federal Reserve had lowered the FFR to a target rate range of 0 to 25 basis points. -Then, to provide further stimulus and liquidity, the Federal Reserve made a series of large-scale asset purchases between late 2008 and 2014. -The primary purpose of these purchases was to lower long-term interest rates to encourage consumption and investment. -The purchases, which were also open market operations, increased the size of the Fed's balance sheet and also dramatically increased the amount of reserves in the banking system.
How has inflation been since the development of the Fed?
-From the early 1950s until 1968, the inflation rate in the United States remained below 4 percent per year. -Inflation rose above 10 percent for several years in the late 1970s and early 1980s. -When Paul Volcker became chairman of the Federal Reserve's Board of Governors in August 1979, he emphasized fighting inflation. -Since 1992, the inflation rate has usually been below 4 percent. -The 2007-2009 recession caused several months of deflation—a falling price level—during early 2009, and the slow pace of the recovery from the recession resulted in another three months of deflation during early 2015.
What additional tools did the Fed introduce to the monetary policy?
-Interest on reserves (IOR)-It applied to both required reserves (paying interest on required reserves, or IORR) and excess reserves (paying interest on excess reserves, or IOER). -IORR eliminates the implicit tax on reserves requirements. -The IOER rate influences banks' decision to hold more or fewer reserves, it gives the Fed an additional tool for conducting monetary policy -Overnight reverse repurchase agreement (ON RRP) facility-The purpose of the ON RRP facility is to set a floor on interest rates. -When an institution uses the ON RRP facility it essentially deposits reserves at the Fed overnight (with a U.S. government security from the Federal Reserve's portfolio acting as collateral) and earns interest (the ON RRP rate) on the deposit.
What does ON RRP (Overnight reverse repurchase agreement) Facility do?
-More types of financial institutions can participate in the ON RRP program than can earn interest on reserves. -These institutions will never be willing to lend funds for lower than the ON RRP rate, the FFR will not fall below the ON RRP rate. -As such, the rate paid on ON RRP transactions acts as a floor for the FFR.
What are some goals of monetary policy?
-Price Stability (a key goal of the Fed) -High Employment -Stability of Financial Markets and Institutions -Economic Growth
What does the FFR (Federal Funds Rate) Range do?
-Rather than setting a single target for the FFR, the target is now communicated as a range 25 basis points wide. The IOER rate and ON RRP rate are used to guide the FFR within the target range. -The FFR will continue to be the primary means of adjusting the stance of monetary policy. -To conduct monetary policy, the FOMC increases or decreases the target range in a manner consistent with its policy goals of price stability and maximum employment.
How can the Federal Reserve raise or lower the FFR?
-The Fed could increase reserves by buying Treasury securities on the open market and crediting the accounts of the seller with reserves as payment. -A greater quantity of reserves shifted the reserves supply curve to the right and put downward pressure on the FFR. And a lower FFR tended to put downward pressure on other interest rates in the economy. -As the supply of reserves decreased, it shifted the reserves supply curve to the left and put upward pressure on the FFR. And as the FFR increased, so did other interest rates.
How do these work in the economy?
-The Fed could increase reserves to decrease the FFR and other interest rates, thereby encouraging economic activity when the economy was in recession. -it could reduce reserves to increase the FFR and other interest rates in an attempt to restrain spending when inflation exceeded its 2 percent inflation objective.
What are monetary policies with scarce reserves?
-The supply of bank reserves is vertical because the supply of reserves collectively held by the banking system is determined by the Federal Reserve. -When reserves are scarce, the Federal Reserve can shift the supply curve to the right or left by adding or subtracting reserves from the banking system using open market operations. The intersection of supply and demand determines the FFR. -The Trading Desk at the Federal Reserve Bank of New York used open market operations to fine-tune the supply of reserves to achieve the target FFR set by the FOMC.
What was the difference between the financial crisis of 1913 and the 2007 recession?
A key difference is that while earlier banking crises affected commercial banks, the events of 2007-2009 also affected investment banks and other financial firms in the shadow banking system. -They were subject to liquidity problems because they often borrow short term and invest the funds in long-term securities. -Just as commercial banks can experience a crisis if depositors begin to withdraw funds, investment banks and other financial firms can experience a crisis if investors stop providing them with short-term loans.
What is the Employment Act of 1946?
Stated that it was the "responsibility of the Federal Government ... to foster and promote ... conditions under which there will be afforded useful employment, for those able, willing, and seeking to work, and to promote maximum employment, production, and purchasing power." -Because price stability and high employment are explicitly mentioned in the Employment Act, it is sometimes said that the Fed has a dual mandate to attain these two goals.
What IOER ( interest on excess reserves) do?
The IOER rate offers a safe, risk-free investment option to banks holding reserves at the Fed. -Given this rate, banks will not lend reserves in the market for less than the IOER rate. -Arbitrage plays a key role in steering the federal funds toward the target. -If the FFR falls very far below the IOER rate, banks have an incentive to borrow in the federal funds market and to deposit those reserves at the Fed, earning a profit on the difference.
What is the Federal Funds Rate?
The interest rate at which a depository institution lends funds that are immediately available to another depository institution overnight. -Arbitrage-If one short-term rate gets much below others, financial institutions will tend to borrow in that market and lend where rates are higher. This tendency puts upward pressure on the lower rate and downward pressure on the higher rate—keeping rates linked.
