The Federal Reserve SystemMonetary PolicyThe Federal Reserve SystemMonetary PolicyThe FedElias YannopoulosOctober 31, 2012Elias Yannopoulos The FedThe Federal Reserve SystemMonetary PolicyWhat is the Fed?The Federal Reserve System - is the central bank of the USIt is the bank for the private banksThe Fed offers loans to banks and accepts deposits from banksThe chairman of the Board of Governors of the FederalReserve System is Ben BernakeHe was originally appointed in 2006 by President Bush and iscurrently serving his second 4 year termThe members of the Board of Governors serve 14 year terms(Bernake is also one of these)The long 14 year term is an effort to keep the Fed from beinginfluences by political motivesThe Fed has 3 major dutiesMonetary Policy - control the money supplyRegulate Banks - (set rr), they are not alone in regulatingbanks the treasury also doesA bank for banks (commercial)Elias Yannopoulos The FedThe Federal Reserve SystemMonetary PolicyThe Fed Cont.The loans the Fed makes to banks are called discount loans.The interest rate on them is the discount rateThis is the only interest rate the Fed has direct control ofThe current discount rate is .75%Bank’s deposits at the Fed are called Federal Funds. They arenot owned by the government that are private funds owned bybanks on deposit at the FedLike your checking accountYou may have heard about the Federal Funds rate, and theFed’s target for itThe Federal Funds rate is the rate at which banks lend toeach other their excess reserves (Federal Funds)The Fed does NOT control this rate directly, they caninfluence it and have a target for the rateThe current target is 0%-.25% and the current rate is .25%Elias Yannopoulos The FedThe Federal Reserve SystemMonetary PolicyMonetary PolicyMonetary Policy is when the Fed changes the money supply(increase or decrease)Today I am going to discuss how they do this and then nexttime go into what effect that has on the economyThe first tool the Fed has is the Reserve Requirement Ratio(rr)First note that this is also the Fed’s main regulation tool, as itwants to make sure that banks have enough on hand to coverdepositsAlso changing rr affects the money supply by changing themoney multiplier (remember simple money multiplier (m) is1rr)↓ rr ⇒↑ m ⇒↑ Deposits ⇒↑ M↑ rr ⇒↓ m ⇒↓ Deposits ⇒↓ MElias Yannopoulos The FedThe Federal Reserve SystemMonetary PolicyMonetary Policy Cont.Why doesn’t the Fed use this tool?It is too powerful - small changes in rr have potentially largeimpacts on the money supplyIt is imprecise - which makes it poor for minor adjustments inthe money supplyIt is unpredictable - because we don’t know how much excessreserves the banks will hold Ex: boardThe last time the Fed used it was April 2nd, 1992The main monetary policy tool of the Fed is Open MarketOperations (OMO)Open market operations are when the Fed buys or sells assets(most likely treasury securities)The Fed uses treasury securities because there is a very deepsupply of them, and they are held by banks which the Fedalready has business withElias Yannopoulos The FedThe Federal Reserve SystemMonetary PolicyMonetary Policy Cont. Cont.How do OMOs work?To increase M, the Fed does an OM PurchaseBuy Treasury Securities ⇒↑ Reserves ⇒ Extra $$ gets loanedout ⇒↑ MTo decrease M, the Fed does and OM SellSell Treasury Securities ⇒↓ Reserves ⇒ Less $$ to loan out⇒↓ MUsing OMOs injects money straight into the veins of thebanking system, the NY Fed is the one that does the actuallytradingOMOs Do not have the downsides of changing the reserveratio as it is very precise and predictableElias Yannopoulos The FedThe Federal Reserve SystemMonetary PolicyMonetary Policy Cont. Cont.The final tool, which you may have heard on the newsrecently is Quantitative EasingQE is a type of OMO, but instead of using short termtreasury securities that use different assetsSince the short term rates were very close to zero (rememberearlier slides on discount and Fed Funds rates) the Fed startedusing longer term Treasury BondsThey also extend QE to the purchase of some assets werethere was trouble in the market (i.e Mortgage-backedSecurities)Elias Yannopoulos The
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