ECN 203 1st Edition Lecture 26Outline of Last Lecture II. Transition to Policy III. The Purpose and Problems of Policy IV. Intervention Outline of Current Lecture V. Federal Reservea. FOMCb. Treasury Dept. VI. Banks and Reserves a. Assets and Liabilities b. Reserve Systemsc. Reserve requirement and FDIC Current LectureLecture 3/27/15- Monetary Policy o Monetary Policy – based on the gov’ts ability to manipulate the supply of financial capital or liquidity In most countries, a central bank manages monetary policy.  In Europe, the European Central Bank manages the monetary policy for all the countries that use the euroo The Federal Reserve, the Fed: the monetary authority of the US. This establishment brings consistency to a national banking system that had once experienced financial panics regularly.  Led by a 7 board members, one who is the Chair that are appointed by the President and approved by the senate The Chair serves a 4-year renewable term  The other members serve a 14-year nonrenewable term. - This allows independence from political control. 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 Federal Open Market Committee (FOMC) – actual decision makers of monetary policy of the US.  Voting members include the seven board members and the Presidents of five of the District federal banks.  The FOMC, under the Fed Chair’s direction, decides the country’s monetary policy. o The Fed vs. Treasury Department  Separate gov’t agencies.  The Fed is independent  Treasury Dept. is part of the Executive Branch, under the President. It collects federal taxes and pays the federal gov’ts bills.  When the gov’t needs to cover a deficit (G>T) (spending more than it’s taxing), the Treasury sells debt paper or securities: bonds, notes, or bills. - When people buy these securities, the US gov’t is loaned money and thebuyers earn interest. - Gov’t and businesses sell securities to borrow financial capital. The sellers are demanders of capital. Individuals or institutions who buy securities in order to make an interest return are suppliers of financial capital.  Buyers of securities can resell them through the open market.  Traditionally, individual owners of debt paper have held them as part of their portfolio because the US has never defaulted when debt arouse. - Hint o Make a connection: The Fed Monetary Policy is directed by the Federal Open Market Committee (FOMC) The term Open Market is included because the Fed directs its monetary policy by contributing in the Open Market for debt paper and securities. - Banks and Reserves o Banks hold both assets and liabilities  Assets – anything owned that has market value and can be distinguished by howliquid it is. I.e. car, cash. Liquid Assets – can be quickly transformed into another assets without losing value. I.e. cash  Illiquid Assets – can be transformed into another asset quickly but will probably lose significant value. i.e. house Reserves – liquid assets a bank holds. They are ready to cover any exercise of a claim on the banks assets without losing value. I.e. cash on hand to cover withdrawals.  Full Reserve System – a perfectly safe bank with all its assets being held in the form of reserves. But this isn’t good for the bank or economy because it turns liquidity that could be loaned out into dead value. - But banks have an incentive to loan out liquidity because of interest.  Fractional Reserve System – banks holding a fraction of its assets as reserves andloaning out the rest to make a return. This is good for the economy because it allows financial capital to be active. - Historically, some banks push it too far. There is an incentive to lend out most of their assets and hold very small reserves because they do not earn anything. - If withdrawals are overwhelming and banks underestimate this it will not have the reserves to meet the demand. - This causes a bank panic. o The Fed established a reserve requirement which is meant to keep banks from taking poor risks.  This establishment was not sufficient enough in the Great Depression because people became “depressed” about the financial system and demanded their money as soon as possible.  To fix this, the gov’t developed the Federal Deposit Insurance Corporation which insures individuals’