Finance 301 1st Edition Lecture 6 Outline of Last Lecture I Why debt security yields vary II Yield Curve III Yield Differentials IV Yield Differentials On Money Market Securities V Yield Differentials On Capital Market Securities VI Estimating Appropriate Yield Outline of Current Lecture VII Organizational structure of the Fed VIII How Fed Controls Money Supply IX How Fed operations effect interest rates X Adjusting Reserve Requirement Ratio XI Adjusting the Fed s Loan Rate XII Feds Lending Role During Credit Crisis XIII Global Monetary Policy Current Lecture I Organizational structure of the Fed a Federal Reserve district banks i We have 12 federal reserve district banks they keep up with their region and regulate them keep up with employment inflation and price levels in their area ii Charter with the federal reserve then they get shares in the federal reserve and become a member bank can be up to 6 dividend iii The jobs are they loan money to member banks and they buy and sell treasuries with their banks and they also replace currency in the circulation for example if they are too damaged to use and they can print new money into economy and they also clear checks b Member Banks i Commercial banks 35 of the banks in this country other 65 percent are state charter banks this means that the state they are charter with regulates them instead of the federal reserve federal deposit insurance ii FDIC insure your checking account up to 250 000 got changed recently used to be 100 000 iii c Board of Governors i 7 people ii They are appointed to 14 year terms by the president and they are staggered every 2 years We give them 14 years because you cant have major changes the economy would go haywire politics wont be involved presidents will come and go and they cant influence these people that much Don t want your politicians influended easily iii Janet yellen alabama iv Vice chairman goes and reports to congress and tell them what theyre working on d Federal Open Market Committee i Made up of the 7 members of the Board of Governors plus the presidents of 5 Fed district banks the New York district bank plus 4 of the other 11 as determined on a rotating basis ii Releases statement on what they are going to do 12 ones that vote on what to do 12 0 11 1 or 10 2 theyre all very one sided iii Federal advice from commercial banks iv Consumer advice from consumers such as me and you how people are doing involvement v Thrift credit unions and savings banks and loans e Advisory Committees i Federal Advisory Council ii Consumer Advisory Council iii Thrift Institutions Advisory Council II How Fed Controls Money Supply a The FOMC meets eight times a year sets targets for the money supply growth level and the interest rate level and implements monetary policy i Pre meeting economic report Beige book a consolidated report of regional economic conditions in each district ii Economic presentations Presentations include data and trends for wages consumer prices unemployment GDP inventories foreign exchange rates interest rates and financial market conditions iii FOMC decisions each member can offer recommendations iv FOMC Statement a statement that summarizes their conclusion v Minutes of FOMC Meeting provided to the public and are also accessible on Federal Reserve websites vi 1 Rate at which banks loan to each other they cant tell the banks what theyre loaning to each other they influence it by adding money to money supply or taking it out 2 Low rate means interest rates would be lower because banks can borrow from other banks without fear of losing money It s a very low rate to borrow influencing banks into loaning more money b Role of the Fed s Trading Desk Open Market Operations i Role of the Fed s Trading Desk Open Market Operations ii If a change in monetary policy is appropriate the FOMC decision is forwarded to the Trading Desk Open Market Desk at the NY Fed through a policy directive iii Fed purchase of securities putting money into money supply to lower interest rates want to control interest rates inflation and try to control economy and unemployment iv Fed sale of securities less supply get picky of who they loan to interest rates go up v Fed trading of repurchase agreements trading the treasuries but trading them with repurchase agreements on holidays and weekends when there is gonna be a lot of spending used for short term money supply growth vi Fed purchasing Mortgage backed securities Piece of paper asset for debt on the house vii Open market operations buying and selling treasuries securities viii Auction off treasuries and securities they are taking on debt to pay their deficits ix When fed purchases securities they are buying from banks they are investors of treasuries from us governments x Taking money out of the money supply xi Control of M1 versus M2 1 The optimal form of money should 1 be controllable by the Fed and 2 have a predictable impact on economic variables when adjusted by the Fed 2 Don t care about keeping records of checking accounts because of spending 3 Monitor money supply by peoples savings investments III How Fed operations effect interest rates a Even though most interest rates are market determined the Fed can have a strong influence on these rates by controlling the supply of loanable funds b Open Market Operations in Response to the Economy i 2001 2003 The Fed frequently used open market operations to reduce interest rates during this period of weak economic conditions ii 2004 2007 The Fed s concern shifted from a weak economy to high inflation as the economy improved They raised interest rates during this time period iii 2008 The Fed used open market operations to reduce interest rates in an attempt to stimulate the economy when economic conditions weakened due to the credit crisis IV Adjusting Reserve Requirement Ratio a What is it How much a bank has to keep how much of your deposits 10 raise or lower this to effect interest rates b From 10 to 15 percent interest rates would rise less supply c V Adjusting the Fed s Loan Rate a Rate that government or federal reserve will loan to banks b 3 percent discount rate if they lower to 2 percent it will lower interest rates because they will borrow more money and then they have more money to lend c Federal funds would be lower because they rather have them borrowing from each other out in economy rather than borrowing new currency from the federal government don t want debt lender of last resort d Discount rate aka