Money Credit Finance: Chapter 3

Describe the structure of the Board of Governors of the Federal Reserve System:

-A board with 7 Governors that play a decisive role in decision making with the federal reserve system (includes chairman)

Monetary Policy Tools

-Affects the macroeconomy by influencing the supply and demand for excess bank reserves -Influences the money supply and the level of short term and long-term interest rates -Affects foreign exchange rates, the amount of money and credit in the economy, and the levels of employment, output, and prices -Federal Reserve can take one of two basic approaches to affect the market for banks' excess reserves (target quantity of reserves, target interest rate on those reserves)

Federal Reserve Banks

-Assist in the conduct of monetary policy (Set and change the discount rate, make discount window loans to depository institutions) -Supervise and regulate FRS member banks (conduct examinations of member banks, issue warnings when banking activity is unsafe or sound, approve bank mergers) -Provide Government Services (Act as the commercial banks of the US Treasury) -Issue New Currency (Collect and replace currency in circulation as necessary) -Clear Checks (act as a central clearing system for US banks -Provide wire transfer services (Fedwire, Automated Clearinghouse ACH) -Perform Banking Sector and economic research

Describe the functions performed by Federal Reserve Banks:

-Assistance in the conduct of monetary policy -Supervision and regulation -Consumer protection and community affairs -Government services: Commercial bank of US Treasury -New currency issued -Check Clearing -Wore Transfer services -Research services

Functions of the Federal Reserve

-Conduct Monetary policy -Supervise and regulate depository institutions -Provide payment and other financial services to the US government, the public, FIs, and foreign official institutions -Maintain financial system stability (Wall Street Reform and Consumer Protection Act) -Has powers to seize or break up institutions whose actions could harm the economy

Structure of Federal Reserve

-Divided into 12 Federal Reserve Districts, each with a main Fed bank -Operates under supervision of the Board of Governors of the Fed -The offices of the Comptroller of the Currency (OCC) charters national banks, which are members of the Federal Reserve System (FRS) -FRS member banks "own" the 12 Federal Reserve Banks

Describe how expansionary activities conducted by the federal reserve impact the money supply, credit availability, interest rates, and securities prices. Do the same for contractionary activities:

-Expansionary: It boosts up the economy by increasing its money supply, increases credit availability for commercial banks, low reserve requirements. For its tools it uses low discount rates, low reserve requirement, and purchase of securities to boost up money supply in the economy. It creates more liquidity in the economy due to which inflation is increased. So it leads to faster increase in demand of consumers. It increases the price of securities -Contractionary: Will contract (lower) the money supply. This is done by risking up the discount rates, large reserve requirements, and selling securities. They decrease the money supply in raw economy, decrease the credit availability, and lower down the prices of securities

What are the primary responsibilities of the Fed Reserve Board:

-Formulation and conduct of monetary policy and supervision and regulation of banks -State chartered banks that are members of Federal Reserve System -Edge Act and agreement corporations (through which US banks conduct foreign operations) -Responsible for the development and administration of regulations governing fair provision of consumer credit (Truth and lending act, Equal credit opportunity act) -Monitoring the country's largest financial firms

What changes did the Fed implement to it's discount window lending policy in the early 2000s, in the late 2000s?

-In 2003 they had changes in it's discount window lending policy that increased the cost of discount window borrowing but eased the requirements on which depository institutions can borrow. As part of this change, the discount window rate was increased so that it would be higher than the fed funds rate. As a result (discount) inter bank loans are normally and relatively small portion of the Fed's total assets -In 2007: The creation of the Term Auction Facility (TAF) in which fixed amounts of term funds are auctioned to depository institutions against any collateral eligible for discount window loans. So while the TAF substituted an auction mechanism for the usual fixed interest rate, this facility can be seen essentially as an extension for more conventional discount window lending

Problems in Conducting Monetary Policy

-Lowering interest rates or supplying money are attempts to stimulate demand, but they may not work -Problems in consumer confidence -High Unemployment -High debt levels -Excessive money creation may reduce the value of the dollar and generate inflation (inflation can cause interest rates to increase, hurting growth) (Loss in confidence of foreign investors could cause higher interest rates, hurting growth)

Balance Sheet of the Federal Reserve

-Major Liabilities: Reserve Deposits, currency in circulation (Currency in circulation + reserves = monetary base -Major Assets: Treasury Securities, US government agency securities

What are the primary responsibilities of the Federal Open Market Committee (FOMC)

-Major monetary policy making body -Formulate policies to promote full employment, economic growth, price stability, and sustainable pattern of international trade -Sets guidelines in open market operations which is the purchase and sale of US government and federal agency securities, main tool to achieve it's monetary targets -Sets ranges for growth of monetary aggregates, sets federal funds rate

What are the tools used by the Federal Reserve to implement monetary policy:

-Open Market Operations: The purchase and sale of US government and federal funds agency securities by the federal reserve -Discount Rate: The interest rate on loans made by federal reserve banks to financial institutions -Reserve Requirements: Rules stating that a percentage of every deposit be set aside as legal reserves

Expansionary Monetary Policy

-Open market purchases of securities by the Fed -Discount rate decreases -Reserve requirement ratio decreases

Open Market Operations

-Policy directive of the FOMC is forwarded to the Federal Reserve Board Trading Desk at the Federal Reserve Bank of NY -Trading Desk manager buys or sells US treasury securities in the over-the-counter (OTC) market, which keeps the fed funds rate near its desired target -FRBNY acts through the Trading Desk to implement policy directives each business day -Operations may be permanent or temporary -May use repurchase agreements for temporary increases or decreases in excess reserves

Board of Governors of the FRS

-Seven member board headquartered in Washington DC -President appoints and Senate confirms members to nonrenewable 14-year terms -President appoints and Senate confirms Chairman and Vice-Chairman to renewable 4-year terms -Formulates and conducts monetary policy and supervises and regulates banks

The Federal Reserve

-Subject to oversight by Congress under its authority to create money -An independent central bank-its decisions do not have to be ratified by the President or Congress

International Monetary Policy

-The Federal Reserve generally allows foreign exchange rates to fluctuate freely. -Foreign Exchange Intervention -Commitments between countries about the institutional aspects of their intervention in the foreign exchange markets -Similar to open market purchases and sales of Treasury Securities

Why does the Federal Reserve rarely use the discount rate to implement its monetary policy?

-The discount rate changes are strong signals of the federal reserve's intentions -There is no guarantee that banks will borrow, or that they'll lend

Discount Rate

-The discount rate is the rate Federal Reserve Banks charge on loans to financial institutions in their district -The Federal Reserve rarely uses the discount rate as a policy tool -Discount rate changes are strong signals of the Federal Reserve Intentions -There is no guarantee that banks will borrow, nor the they would lend.

Federal Open market Committee (FOMC)

-The major monetary policy-making body of the FRS -Policies seek to promote full employment, economic growth, price stability, and a sustainable pattern of international trade -Sets ranges for growth of monetary aggregates and the fed funds rate, and also directs operations in FX markets -Open market operations are the main policy tool used to achieve monetary targets: -Involve the purchase and sale of US gov and fed agency securities -Are implemented by the Fed Board Trading Desk of the NY Fed Reserve Bank -Consists of 12 members -7 members of the Board of Governors -The President of the Federal Reserve Bank of NY -The presidents of four other federal reserve banks on a rotating basis

Reserve Requirements

-The reserve assets depository institutions must keep to "back" transaction deposits -Reserve assets include vault cash and deposits at Federal Reserve Banks

Why did reserve deposits increase to the point that this account represented the largest liability account on the Federal Reserve's Balance Sheet in the late 2000s:

-To try and save the economy during the Great Recession, the Fed's lending policy generated a large quantity of excess reserves without changing banks incentives to lend to firms and households. Thus the total level of reserves in the banking system is determined almost entirely by the actions of the central bank, and is not necessarily affected by private banks lending decisions.

What are the major assets of the Federal Reserve System

-Treasury and government agency (Fannie Mae, Freddie Mac) securities -Treasury Currency -Gold and foreign Exchange

Contractionary Monetary Policy

-open market sales of securities by Fed -Discount rate increases -Reserve requirement ratio increases

Summarize the monetary policy measures taken by central banks to address the worldwide financial crisis:

Central banks were all part of a coordinated effort by major countries to ease the monetary conditions brought by the financial crisis and avoid a deep worldwide recession. Rescue programs in Australia, Canada, France, Germany, Italy, Japan, The Netherlands, Spain, Switzerland, the UK, and US central banks can be characterized into four general areas: expansion of retail deposit insurance, capital injections, debt guarantees, and asset purchases guarantees

Explain how a decrease in the discount rate affects credit availability and money supply:

Changing the discount rate signals top of the market economy that the federal reserve would like to see higher or lower rates in the economy. For example raising the discount rate signals that the Fed would like to see a tightening of monetary conditions, and higher interest rates in general, while lowering the discount rate signals a desire to see more expansionary monetary conditioning and lower interest rates in general

Define the discount rate and the discount window:

Discount Rate: The interest rate on loans made by Federal Reserve Bank issues loans to Financial institutions Discount Window: The facility through which Federal Reserve Banks issue loans to Financial Institutions

What are the major liabilities of the Federal Reserve System? Describe:

Liabilities are located in the Federal Reserve Balance Sheets which includes: -Reserves: Contains all deposits of federal bank plus vault cash, contains liquid assets under it -Monetary Base: The sum of all cash in circulation and reserves. Currency in circulation leads to fluctuation in the money supply. Refers to sum of: bank deposits and reserves -Currency Outside Bank: largest liability, federal notes are biggest source of exchange -Deposits of Depository Institutions: They buy and sell in the federal funds market, transactions are between the lender's reserve bank account and borrower's bank account -Deposits of US treasury: Divided into two parts: receipts and expenditures. Not only affects the balance of treasury account, but also affects the balance in accounts that are maintained by depository institutions -Other Deposits: Government Sponsored Enterprises (GSEs) maintains deposit account in Federal Reserve. When there is an increase in the "other deposits" then it indicates the transfer of funds from depository institutions to the GSEs

Which of the Monetary tools available to the federal reserve is most often used, why?

Open Market Operations: Because they are flexible, and this the most frequently used tool of monetary policy. The discount rate is the interest rate charged by the federal reserve banks to depository institutions

Global Rescue Programs

Responses by major central banks to the financial crisis: -Expansion of retail deposit insurance -Direct injections of capital to improve lender's balance sheets -Debt Guarantees -Asset purchases or asset guarantees -Stress tests of banks

Why did the US government agency securities go from nothing to being the largest asset account on the Federal Reserves' balance sheet in the late 2000s

The account grew as the Fed took steps to improve credit market liquidity and support the mortgage and housing markets during the financial crisis by buying mortgage back securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Under the MBS purchase program, the FOMC called for the purchase of up to $1.25 trillion of agency MBC. The purchase activity began in Jan 2009 and continued to March 2010