Chapter 18 Tools of Monetary Policy I The Market for Reserves and Federal Funds Rate a Demand and Supply in the Market for Reserves i There is a supply and demand of interests rates ii Demand Curve 1 can be split into required Reserves and Excess Reserves a as the federal funds rate decreases the opportunity cost of holding excess reserves falls i causing the Quantity Demanded of reserves iii Supply Curve 1 can be split into to rise a reserves borrowed through Fed open Market Operations NBR also called non Borrowerd Reserves b Reserved Borrowered from The Fed BR b How Changes in the Tools of Monetary Policy Affect Open Market iv Market Equilibriumd Operations i Open Market Operations 1 depends on whether supply curve initially intersects the demand curve in its downward sloped section versus its flat section 2 purchase leads to greater reserve supply a causes federal funds rate to drop b UNLESS i Supply curve intersects the demand curve on its flat section then NO effect c Interest rate paid on reserves sets a floor for the federal funds rate 1 Most of the time changes in the discount rate have no effect on the federal funds rate 2 Exception is when demand curve intersects the supply ii Discount Lending curve on its flat section iii Reserve Requirements 1 Fed raises reserve requirement federal funds rate rises 2 Fed decreases reserve requirement federal funds rate falls II Open Market Operations a Purchase in Open Market i Expand reserves and monetary base ii Increase money supply iii Lower short term interest rates b Sales in Open Market i Shirnk reserves and monetary base ii Raising short term interests rates c Dynamic Open Market Operations reserves and the monetary base d Defense Open Market Operations factors that affect reserves and the monetary base i Changes in Treasury deposits with Fed ii Changes in Float intended to change the level of intended to offset movents in other III Discount Policy a Discount Window the Federal Reserve is called the discount Window the facility at which banks can borrow reserves from i Operations 1 Primary Credit healthy banks are allowed to borrow all they want at very short maturities Also called Short Lending Facility a most important role in monetary policy b intended to be a backup source of liquidity for sound banks so there federal funds never rise too far above federal funds rat 2 Secondary Credit given to banks that are in financial trouble that are experiencing sever liquidity problems deposits given to banks that have seasonal levels of 3 Seasonal Credit a Farm banks b Vacation banks b Lender of Last Resort control to provide reserves to banks when no one else would in order to prevent bank and financial panics to prevent banks failures from spinning out of i Creastes moral hazard problem because banks are more willing to engate in risky lending and trading IV Reserve Requirements a Cause money supply multiplier to change i A rise in reserve requirement reduces the amount of deposits that can be supported by a given level of the monetary base and will lead to a contraction of the money supply ii A rise in reserve requirement also increases the demand for reserves and raises the federal funds rate
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