chapter 4 the fed and monetary policy © 2003 south-western/thomson learning
TRANSCRIPT
CHAPTER
44The Fed and Monetary Policy
© 2003 South-Western/Thomson Learning
Chapter ObjectivesChapter Objectives
Identify the Fed’s role in monetary policy Describe the tools the Fed uses to influence
monetary policy Explain how changes in regulation in the
1980s affected the Fed and monetary policy
Federal Reserve System: Third U. S. Federal Reserve System: Third U. S. Central BankCentral Bank
First Bank of the United States (1791–1811)
Second Bank of the United States
(1816–1836)
Federal Reserve System (1913–)
Structure of the Federal Reserve SystemStructure of the Federal Reserve System
12 Fed District Banks Member Commercial Banks 7 Members of Board of Governors 14 year terms for Governors 12 Open Market Committee (FOMC)
Members Advisory Committees to Fed from private
sector
Functions of the Federal Reserve SystemFunctions of the Federal Reserve System
Effect Monetary Policy U.S. Central Bank In International Area Fiscal Agent of U.S. Treasury Facilitate Efficient Payments System Regulate Banks and Bank Holding Co. Enforce Consumer Credit Laws
Organization of the Federal ReserveOrganization of the Federal Reserve
Federal Reserve District Banks 12 districts Districts divided by population at 1912–13 District bank size related to economic wealth of
district District banks owned by private member banks Board of Directors of district banks
Three appointed by Board of Governors Three professional bankers Three business persons in district
Organization of the Federal ReserveOrganization of the Federal Reserve
Member Banks Must meet requirements of the Federal Reserve
Board of Governors to be a member bank Nationally chartered banks must be member banks State chartered banks may be member banks 35% of banks controlling 70% of all deposits are
members
Organization of the Federal ReserveOrganization of the Federal Reserve
Board of Governors 7 individuals appointed by the U.S. president and
confirmed by the Senate U.S. president appoints one of the 7 chair whose
4-year term is renewable Offices in Washington, D.C. Serve nonrenewable 14-year terms Independence of Federal Reserve
Staggered terms of Governors Budget separate from Congress
Organization of the Federal ReserveOrganization of the Federal Reserve
Board of Governors has two main functions: Regulate commercial banks
Supervise and regulate member banks and bank holding companies
Oversight of 12 Fed district banks Establish consumer finance regulations after
Congressional legislation
Organization of the Federal ReserveOrganization of the Federal Reserve
Establish and effect monetary policy
Direct control over two tools of monetary policy Set reserve requirements Approve discount rate set by district banks
Indirect control in a third area Governors are members of the Federal Open Market
Committee
Organization of the Federal ReserveOrganization of the Federal Reserve
Federal Open Market Committee (FOMC) meets every 6 weeks 12 members
7 from the Board of Governors President of the New York Fed 4 other district bank presidents appointed on a rotating
basis Other presidents participate but do not vote on monetary
policy matters
Organization of the Federal ReserveOrganization of the Federal Reserve
Federal Open Market Committee (FOMC) Monetary policy goals of:
high employment price stability economic growth
Make monetary policy decisions to achieve goals Forward decisions to N.Y. Fed open market desk
Advisory committees from private sector also are a part of overall structure of the Fed
Fed’s Influence on EconomyFed’s Influence on Economy
Fed influences liquidity (supply of loanable funds) in money market to influence:
Liquidity,Money Supply
andInterest Rates
Business and ConsumerBorrowing/Spending
Goals of Growth
Price StabilityJob Growth
Tools of Monetary PolicyTools of Monetary Policy
Tools ofMonetary
Policy
OpenMarket Op.
Reserve Req. Discount Rate
How Fed Controls Money SupplyHow Fed Controls Money Supply
Banks must maintain reserves as percent of deposits
Reserves kept as deposits in Fed (plus vault cash)
Fed controls level of member bank reserve deposits in Fed
Fed influences bank deposit portion of money supply
Monetary Policy ToolsMonetary Policy Tools
Open market operations involve the purchase or sale of government securities based on FOMC directives sent to N.Y. Fed Trading Desk
Open market purchase of government securities: Purchase securities from government securities
dealers Increase bank deposits and bank reserves, money
market liquidity and, in time… Increases the money supply
Exhibit 4.4Exhibit 4.4
$100 million
$90 million
$81 million
$10 million
$9.0 million
$8.1 million
Increase indepositsat banks
Required reservesheld on
new deposits
Funds received fromnew deposits that
can be lent out
$90 million
$81 million
$72.9 million
Monetary Policy ToolsMonetary Policy Tools
Open market operations and interest rates Most rates are market determined but Fed
influences federal funds interest rate Fed purchase of securities results in an injection of
additional funds into the bank system Shifts supply of federal funds to the right Lowers federal funds rate Lower rates spread to other money market securities
More funds available for money market and bank lending
Monetary Policy ToolsMonetary Policy Tools
Adjusting the discount rate Depository institutions borrow from Fed for three
reasons: Adjustment credit for short-term reserve deficiencies Seasonal credit to agricultural banks Extended credit for longer-term liquidity problems of
problem banks
Lower discount rate More bank borrowing from Fed, bank reserves expand,
money supply increases
Monetary Policy ToolsMonetary Policy Tools
Adjusting the reserve requirement ratio Proportion of deposits at depository institutions
set aside to meet their reserve requirements Increase in lending or expansion limited by ($)
reserves bank must hold the meet reserve requirements (%)
Total dollar expansion effect as follows:
Dollar amount of open marketFed purchase or discount loan ×
1
RR
Comparison of Policy ToolsComparison of Policy Tools
Increasing the money supply Open market operation purchase of securities via
the Trading Desk in the secondary market Discount rate lowered to encourage borrowing at
the discount window Reserve requirements lowered
Comparison of Policy ToolsComparison of Policy Tools
Decreasing the money supply Open market operation sale of securities via the
Trading Desk in the secondary market Discount rate raised to encourage borrowing at the
discount window Reserve requirements raised
Monetary Policy Deposit Expansion Monetary Policy Deposit Expansion ProvidesProvides
Excess Reserves to Lend Loan/Deposit Expansion Loans Finance Spending Potential Expansion = Added $ Reserves
1/Required Reserve Ratio
Limiting Factors to Deposit ExpansionLimiting Factors to Deposit Expansion
Banks may not lend excess reserves Public may not re-deposit payments In
expansion process (cash drains) Lowers deposit expansion multiplier Other fed functions impact member bank
reserve level
Federal Reserve Policy EmphasisFederal Reserve Policy Emphasis
Money Supply Growth Interest Rate Levels Price Level Changes Real Economic Activity
Monetary Control Act of 1980Monetary Control Act of 1980
To regain more control over the money supply the MCA required all depository institutions to Meet the same reserve requirements Hold noninterest-bearing reserves Promptly report deposit levels to the Fed
Other provision of the MCA allowed all depository institutions To offer transaction accounts Access to the discount window
Global Monetary PolicyGlobal Monetary Policy
Each country has its own central bank and often industrialized countries have banks with similar goals
Integration in the global economy means the Fed must consider conditions in other countries when looking at the U.S. economy
Central banks try to work together but conflicts of interest can make cooperation difficult at times
Global Monetary PolicyGlobal Monetary Policy
A single European monetary policy Euro replaced national currencies of 11 countries
in January 1999 National currencies withdrawn and replaced by
euro by June 1, 2002 Countries of the 15 in the European Union needed
to meet economic criteria and chose to join Created a European Central Bank