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UGA ECON 2105 - Module 27
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ECON 2105 1nd Edition Lecture 20 Outline of Last Lecture I. Banks Creating Money Outline of Current Lecture I. Federal Reserve Banks II. Open-Market Operations Current LectureModule 27 Federal Reserve: Monetary Policy I. Federal Reserve Bank - The Federal Reserve is a central bank; it oversees and regulates the banking system and controls the monetary base.- Three Conventional Instrumentso Reserve ratioo Discount rateo Open Market Operations (O.M.O.)- Ben Bernanke- 14th chair of the Fed, Assumed office 2/1, 2006- Atlanta is in the 6th region of the federal reserve system - Reserve requirements and the discount rate: What does a bank do if it can’t meet the Fed’s reserve requirement?o The federal funds market allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserveso The federal funds rate (FFR) is the interest rate determined in this market.o Federal funds- suppliers bank with excess reserves o Demanders banks in short of reserves - Option 1 is to borrow from other banks (low interest rates) - Last option is to borrow from the fed. (high interest rates) it is discouraged - Reserve Requirements and the Discount Rate: These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.o The discount rate is the rate of interest the Fed charges on loans to banks.o Normally, the discount rate is set 1 percentage point above the federal funds rate in order to discourage banks from turning to theFed when they are in need of reserves.o How about nowadays?-II. Open-Market Operations (OMOs) - Most flexible and frequently used- The goal is to have an impact on reserve balances.- Can the Fed have an impact on Reserve balances without conducting any OMOs?- The Federal Open Market Committee (FOMC) is the Federal Reserve System’s top monetary policy-making body.- When the Fed buys anything (even socks), Bank reserves increase.- Fed chooses government bonds to buy and sell daily.o The Fed can buy and sell billions of dollars’ worth of government bonds in minutes. - The Fed usually buys and sells short-term bonds called Treasury bills, or T-bills (sometimes also called Treasury securities or Treasuries).- T-bills: short term government bonds (less than 1 year) - Balance sheet of the fed: right hand side is called monetary base (liability of the bank). Assets LiabilitiesOther assets CurrencyT-bills Bank ReservesForeign Currency or other stuf- To increase the money supply, the Fed must inject reserves into the system (the banks mostly).- To decrease the money supply, the Fed must remove reserves from the system (from the banking sector).- Practice: If the Fed conducts an open market sale of $100 million t- bills (fed sells t-bills, banks buy the t-bills), What will be the initial impact on banks’ excess reserves?o The bank reserves will go down by the amount of the sale o Excess reserves will go down - If the Fed conducts an open market sale of $100 million t- bills, What will be the initial impact on monetary base?o MB= C+ bank reserves o Bank reserves will go down o But no impact on Co Monetary base will go down by the same amount as bank reserves - If the Fed conducts an open market sale of $100 million t- bills, What will be the impact on Fed’s assets?o Assets- t-bills went down, other assets o Liabilities- C, bank reserves went down o Fed assets will also fall - If the Fed conducts an open market sale of $100 million t- bills, What will be the initial impact on commercial banks’ liabilities?o No intial change in deposits o No change in liabilities - If the Fed conducts an open market sale of $100 million t- bills, What will be the initial impact on commercial banks’ assets?o There will be a change in the assets o T-bills go up , loans, bank reserves go down - An open-market purchase of $100 million worth of bonds: banks gain reserves. (fed is buying t-bills) in return they credit the amounto Federal reserve- t-bills go up, monetary base goes up o Commercial banks- t-bills go down, reserves go up --- all open market charges afect bank reserves - How the fed increases money supply? BUY BUY BUY - Fed:- Assets - Liabilities- Other assets - Currency- T-bills go up - Bank Reservesgo up - Foreign Currency-- How the fed increases money supply: BUY t-bills - Commercial banks - Assets - Liabilities- T-bills go down - Deposits- Loans -- Bank Reserves go up -- Banks will later increase their loans and increase the money supply. - How the Fed decreases money supply: SELL SELL SELL - Fed:- Assets - Liabilities- Other assets - Currency- T-bills go down - Bank Reserves go down - Foreign Currency -- Sell to banking sector, and bank pays from reserves - How the fed decreases money supply: SELL SELL SELL - Commercial Banks: - Assets - Liabilities- Bonds will go up - Deposits- Loans -- Bank Reserves go down -- Banks will later decrease their loans and decrease the money supply. - Where does the Fed get the funds to purchase U.S. Treasury bills fron the banks? o By crediting the banks’ accounts with extra reserves. o The Fed does NOT need to print money.- How open- market works: - If the Fed wants to increase the money supply, it will buy T-bills:-- If the Fed wants to decrease the money supply, it will sell T-bills:-M↑ as themoney creationprocess ripplesthrough the economyWith more reserves, bank↑ loansFed electronically↑reserves of thebanks To pay forthe T-billsM↓ as themoney creationprocess ripplesin reverse throughthe economyWith fewer reserves, bank↓ loansFed sellsT-bills- Suppose this is the only bank in the banking system. Furthermore, suppose all money is held in this bank and the bank holds no excess reserves. If the Fed makes an open-market sale of $50 worth of T-bills to this bank, what will happen to the money supply at the maximum after all adjustments are made?o The money supply will increase by $50.↓reserves of the banksWhich of the following statement is most accurate?A) If the Fed has an open market purchase of T-bills in the amount $50 billion, both bank reserves and monetary base decrease by $50 billion.B) If the Fed has an open market purchase of T-bills in the amount $50 billion, the liabilities of the commercial banks decrease by $50 billion.C) If the Fed


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