Lecture 14: Monetary PolicyBank of England 1694Banks of the United StatesNineteenth Century Problems and SolutionsFederal Reserve System - 1913Slide 6Board of GovernorsBanking Panic of 1933European Central BankNew Euro CurrencySlide 11Bank of JapanSlide 13Nikkei Index Monthly 1984-I to 2004-IIMonetary Problem in JapanReserve RequirementsFOMCTrading Desk, FRBNYDiscount Rate and Federal Funds RateSlide 20Slide 21Changed Definition of Discount RateFederal Funds Rate and Inflation Rate Monthly 1954-VII to 2004-IReal Federal Funds Rate Monthly 1954-VII to 2004-IStabilization and 1980 and 1981-2 RecessionsStabilization and 1990-1991 recessionThe 2001 RecessionLecture 14: Monetary PolicyBank of England 1694•Granted monopoly on joint stock banking by Parliament in return for war loans.•Not an invention of economists, started off as a powerful bank that was able to demand that other banks held deposits in it.•Did not have government monopoly on note issue, but achieved it through its monopoly power.Banks of the United States•Loosely modeled after Bank of England•First Bank of the United States 1791-1811, was promoted by Alexander Hamilton•Second Bank of the United States 1816-1836. President Andrew Jackson called it a “dangerous monopoly,” conflict with Nicholas Biddle, president.•Suffolk System, MassachusettsNineteenth Century Problems and Solutions•Privately issued bank notes•Discounts on notes•Banking panics associated with business depressions•National Banking System, 1863, mostly ended panics until 1907.•1907 panic saved by J. P. Morgan•Under National Banking System inflexible money supply, strongly seasonal interest rate•Led to creation of Federal ReserveFederal Reserve System - 1913•Created flexible money supply, responding to business situation•Fed was lender of last resort•12 Regional banks, each presides over a district.•Two in Missouri•Board of Governors in Washington DCBoard of Governors•7 members, 14-year terms•Chairman has 4-year term. Traditional power of the chairman•Independent of executive and legislative branch. An “independent central bank.”•Chairman must make semiannual monetary policy reports (Humphrey Hawkins)Banking Panic of 1933•Despite Fed’s lending, a banking panic forced Roosevelt to declare a banking holiday•Led to establishment of Federal Deposit Insurance Company (FDIC) opened doors in 1934, funded by premia paid by banks•No U. S. panics sinceEuropean Central Bank•Founded 1998•Eurozone members and non Eurozone members•Had to construct Eurozone data for first time•President Jean-Claude Trichet since 2003•Otmar IssingNew Euro Currency•Currency first issued January 1, 2002•“The parallel lines [in €] “represent the stability of the euro.”Bank of Japan•Toshihiko Fukui, Governor since 2003•Interest rates have been brought down virtually to zero•Purchase of government bonds to try to stimulate economy•Proposals to buy foreign bonds, dollars•Japanese banks sitting on unlent fundsNikkei Index Monthly 1984-I to 2004-IIMonetary Problem in Japan•Inflation often negative•Gensaki rate zero•Real rate often substantial, Bank of Japan can do nothing•Svensson proposal to peg yen at, say, 160 to dollar, unheeded by conservative B of JReserve Requirements•Depository Institutions Deregulation and Monetary Control Act of 1980: 12% reserves on demand deposits, 3% on time•Act allows Fed to change reserve requirements, on demand deposits within range 8% and 14%.•Banks must meet requirements over two-week statement period•Reserves are in cash or balances with federal reserve. FedwireFOMC•Federal Reserve Board, President of New York Fed, and four other reserve bank presidents.•Meets roughly once a month•Since 1994, has made immediate announcements of policy decision•Since 1997 has made immediate announcements of federal funds rate targetTrading Desk, FRBNY•Buys and sells Treasury bills•August 1999 FOMC gave desk authorization to trade in mortgage-backed securities•FOMC is studying allowing desk to trade in debt of states, or foreign countries.Discount Rate and Federal Funds Rate•Discount rate is rate on loans Fed makes to member banks.•Borrowing is a privilege, not a right•Federal funds rate is rate of interest banks pay to each other when they lend excess reserves.•Repo rate is collateralized, hence tends to be a little lower.Changed Definition of Discount Rate•Prior to 2003, discount rate was usually 50 basis points lower than the funds rate•Then, borrowing at discount window carried stigma•On Jan 9, 2003, Fed raised discount rate above funds rate, eliminating stigma•Primary discount rate (sound banks) about 100 basis points above funds rate•Secondary discount rate (banks that do not qualify) 50 points above primary discount rateFederal Funds Rate and Inflation Rate Monthly 1954-VII to 2004-IReal Federal Funds Rate Monthly 1954-VII to 2004-IStabilization and 1980 and 1981-2 Recessions•New Fed Chairman Paul Volcker thought inflation had gotten out of hand.•Created “the great recession” that stopped inflation•Many foreign countries similar experienceStabilization and 1990-1991 recession•Fed was misled by inaccurate GDP numbers, didn’t see recession coming.•First started cutting interest rates Dec. 1990, after recession had been on for six monthsThe 2001 Recession•Not brought on by rising interest rates to curb inflationary pressure•A post-stock-market bubble recession•Dramatic cuts in rates starting early 2001•Recession short lived (March-November)•Housing boom started by rate