CHAPTER 19 Organization of Central Banks 12 Federal Reserve Districts none only one state TEST 2 o Each has a president o Board of directors of each federal bank has nine members A Bankers 3 B Industry Commerce or Agriculture 3 C Public interest 3 NOTE This board elects the president of district bank o Each has a district bank to conduct discount lending Districts created to contain a mixture of economic interests Theoretically the private commercial banks that belong to Federal Reserve system in each district own the district bank o Reality Joint private government venture Member banks o All national banks required to be members of the Fed o State banks can decide Fed has reserve requirements require banks to keep certain amount of funds No interest was paid on these funds Basically a tax on the banks o Later Law Required all banks to keep reserves on deposit Gave equal access to the discount loans and payment system Board of Governors o 7 members appointed by US president 12 People on the Federal open market 7 from US president o They must be confirmed by US senate o Members serve 14 year nonrenewable terms o Functions Administers of monetary policy flow of money Open market operations Sets reserve requirements how much money the banks need to have Operates the discount window To control monetary flow they buy and sell bonds Duties relating to financial regulation Setting margin requirements for securities purchases Chairman of the BOD o Appointed by president o Confirmed by US senate o Serves a 4 year term o At expiration can be reappointed for an additional of serve out remaining 10 years as a member o Very influential in setting monetary policy and shaping economic policy o Popularized by Allen Greenspan currently Bernanke Federal Open Market Committee o 12 members o Directs FED s open market operations o Members of FOMC Board of Governors 5 District bank presidents one of which is always the New York district bank president The FOMC issues directives to the trading desk at the NY district bank o Federal Funds rate rate of interest banks charge each other Power in the FED o Formal structure defuses power between the B of G the 12 Fed reserve banks and the FOMC o Informal power lies with the chairman Member banks have little actual influence Handling External Pressure o The Fed was designed to operate independently of external pressures political o Reality Fed operates in a political arena Fed Motivation o Public interest view FED acts in best interest of the general public o Principal Agent View Fed acts to increase its power influence and prestige Implies there may be a political business cycle Evidence of a political business cycle is weak Fed independence o Political issue of Fed s independence arises when the public negatively views FED policy o Pro independence Monetary policy is too important Politicians focus on short term Monetary too technical politicians o Con Independence too important Only elected officials should make public policy CHAPTER 20 Monetary Policy Tools The business Cycle o Regular fluctuations in economic activity o 1st Phase Expansion growing economy Jobs up income up output up and interest rates up o 2cd Phase Decline economy slows and eventually turns downward o 3rd Phase o 4th Phase Recession economy stops growing At some point the economy bottoms and begins to rebound trough Recovery economy begins to grow again Fiscal Policy secretary of the treasury o Changes in taxing and spending by the federal government with the intent of expanding or contracting the demand of the economy o In a recession an expansionary fiscal policy involves lowering taxes and increasing government spending o In an overheated economy a contractionary fiscal policy requires higher taxes and reduced spending Monetary Policy o Controlled by FED o Changes in interest rates and money supply to expand or contract o In a recession the FED lowers interest rates and increases the money demand in the economy supply o Overheated Raises interest rates and decreases money supply FED has 3 tools to control monetary policy o Open Market Operations Fed buys and sells securities in the financial markets Treasury Bills short term issues by the government FOMC guides open market operations Open market purchases are expansionary Open market sales are contractionary FOMC issues a general directive stating its overall policy objectives Federal Funds Rate Rate that banks charge one another for very short loans typically overnight loans to meet reserve requirements NOT SET BY FED Determined by supply and demand target set by fed Types NY Performed by trading desk at Federal reserve bank of Dynamic transactions change monetary policy o Outright purchases and sales Defensive transactions used to make adjustments to the monetary base offset disruptions o Much more common o May be expected or unexpected major or minor o Repurchase and reverse repurchase agreements Advantages o Control o Discount Lending Discount Window Discount policy Affects money supply by influencing the volume of discount loans o Harder because the banks have to borrow they cant make them do it Discount window Means or making discount loans o Increase monetary base and increase money supply Fed sets the discount rate changes volume of loans Higher rate reduced borrowing o Higher pressure on short term interest rates Discount rate is typically set higher than the Fed funds rate It costs more for a bank to borrow money from the fed than from another bank o Types of discount loans Primary Credit lowest rate Secondary Credit all other banks don t meet the requirement pay higher rate Seasonal Credit More help when loans are needed Most direct way for the Fed to act as the banking system s o Advantages of Discount lender of last resort Signals Fed s intentions o Disadvantages Harder to control the impact of the money supply than open market operations May have unintended consequences o Reserve Requirements Banks must hold part of their deposits in cash or as deposits Rarely change indicates a major change in monetary policy Every two weeks the Fed monitors compliance with its reserve with the Fed requirements Debate continues on what the Fed s role should e in setting reserve requirements Fed is growing economy vs Inflation price stability o Increasing prices erodes money value hyper inflation o Market economy Prices are determined by the market o Informational content of prices goes down o Uncertainty of Risk Firms are hesitant to
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