Download Document

CHAPTER
4
The Fed and
Monetary Policy
© 2003 South-Western/Thomson Learning
Chapter Objectives
n
n
n
Identify the Fed’s role in monetary policy
Describe the tools the Fed uses to influence
monetary policy
Explain how changes in regulation in the
1980s affected the Fed and monetary policy
Federal Reserve System: Third U. S.
Central Bank
n
First Bank of the United States (1791–1811)
n
Second Bank of the United States
(1816–1836)
n
Federal Reserve System (1913–)
Structure of the Federal Reserve System
n
n
n
n
n
n
12 Fed District Banks
Member Commercial Banks
7 Members of Board of Governors
14 year terms for Governors
12 Open Market Committee (FOMC)
Members
Advisory Committees to Fed from private
sector
Functions of the Federal Reserve System
n
n
n
n
n
n
Effect Monetary Policy
U.S. Central Bank In International Area
Fiscal Agent of U.S. Treasury
Facilitate Efficient Payments System
Regulate Banks and Bank Holding Co.
Enforce Consumer Credit Laws
Organization of the Federal Reserve
n
Federal Reserve District Banks
l
l
l
l
l
12 districts
Districts divided by population at 1912–13
District bank size related to economic wealth of
district
District banks owned by private member banks
Board of Directors of district banks
u
u
u
Three appointed by Board of Governors
Three professional bankers
Three business persons in district
Organization of the Federal Reserve
n
Member Banks
l
l
l
l
Must meet requirements of the Federal Reserve
Board of Governors to be a member bank
Nationally chartered banks must be member banks
State chartered banks may be member banks
35% of banks controlling 70% of all deposits are
members
Organization of the Federal Reserve
n
Board of Governors
l
l
l
l
l
7 individuals appointed by the U.S. president and
confirmed by the Senate
U.S. president appoints one of the 7 chair whose
4-year term is renewable
Offices in Washington, D.C.
Serve nonrenewable 14-year terms
Independence of Federal Reserve
u
u
Staggered terms of Governors
Budget separate from Congress
Organization of the Federal Reserve
n
n
Board of Governors has two main functions:
Regulate commercial banks
l
l
l
Supervise and regulate member banks and bank
holding companies
Oversight of 12 Fed district banks
Establish consumer finance regulations after
Congressional legislation
Organization of the Federal Reserve
n
Establish and effect monetary policy
l
Direct control over two tools of monetary policy
u
u
l
Set reserve requirements
Approve discount rate set by district banks
Indirect control in a third area
u
Governors are members of the Federal Open Market
Committee
Organization of the Federal Reserve
n
Federal Open Market Committee (FOMC)
meets every 6 weeks
l
12 members
u
u
u
u
7 from the Board of Governors
President of the New York Fed
4 other district bank presidents appointed on a rotating
basis
Other presidents participate but do not vote on monetary
policy matters
Organization of the Federal Reserve
n
Federal Open Market Committee (FOMC)
l
Monetary policy goals of:
u
u
u
l
l
n
high employment
price stability
economic growth
Make monetary policy decisions to achieve goals
Forward decisions to N.Y. Fed open market desk
Advisory committees from private sector also
are a part of overall structure of the Fed
Fed’s Influence on Economy
n
Fed influences liquidity (supply of loanable
funds) in money market to influence:
Liquidity,
Money Supply
and
Interest Rates
Business and Consumer
Borrowing/Spending
Goals of
Growth
Price Stability
Job Growth
Tools of Monetary Policy
Open
Market Op.
Tools of
Monetary
Policy
Reserve Req.
Discount
Rate
How Fed Controls Money Supply
n
n
n
n
Banks must maintain reserves as percent of
deposits
Reserves kept as deposits in Fed (plus vault
cash)
Fed controls level of member bank reserve
deposits in Fed
Fed influences bank deposit portion of money
supply
Monetary Policy Tools
n
n
Open market operations involve the purchase or
sale of government securities based on FOMC
directives sent to N.Y. Fed Trading Desk
Open market purchase of government securities:
l
l
l
Purchase securities from government securities
dealers
Increase bank deposits and bank reserves, money
market liquidity and, in time…
Increases the money supply
Exhibit 4.4
Increase in
deposits
at banks
Required reserves
held on
new deposits
Funds received from
new deposits that
can be lent out
$100 million
$10 million
$90 million
$90 million
$9.0 million
$81 million
$81 million
$8.1 million
$72.9 million
Monetary Policy Tools
n
Open market operations and interest rates
l
l
Most rates are market determined but Fed
influences federal funds interest rate
Fed purchase of securities results in an injection of
additional funds into the bank system
u
u
u
l
Shifts supply of federal funds to the right
Lowers federal funds rate
Lower rates spread to other money market securities
More funds available for money market and bank
lending
Monetary Policy Tools
n
Adjusting the discount rate
l
Depository institutions borrow from Fed for three
reasons:
u
u
u
l
Adjustment credit for short-term reserve deficiencies
Seasonal credit to agricultural banks
Extended credit for longer-term liquidity problems of
problem banks
Lower discount rate
u
More bank borrowing from Fed, bank reserves expand,
money supply increases
Monetary Policy Tools
n
Adjusting the reserve requirement ratio
l
l
l
Proportion of deposits at depository institutions set
aside to meet their reserve requirements
Increase in lending or expansion limited by ($)
reserves bank must hold the meet reserve
requirements (%)
Total dollar expansion effect as follows:
Dollar amount of open market
Fed purchase or discount loan
×
1
RR
Comparison of Policy Tools
n
Increasing the money supply
l
l
l
Open market operation purchase of securities via
the Trading Desk in the secondary market
Discount rate lowered to encourage borrowing at
the discount window
Reserve requirements lowered
Comparison of Policy Tools
n
Decreasing the money supply
l
l
l
Open market operation sale of securities via the
Trading Desk in the secondary market
Discount rate raised to encourage borrowing at the
discount window
Reserve requirements raised
Monetary Policy Deposit Expansion
Provides
n
n
n
n
Excess Reserves to Lend
Loan/Deposit Expansion
Loans Finance Spending
Potential Expansion = Added $ Reserves 
1/Required Reserve Ratio
Limiting Factors to Deposit Expansion
n
n
n
n
Banks may not lend excess reserves
Public may not re-deposit payments In
expansion process (cash drains)
Lowers deposit expansion multiplier
Other fed functions impact member bank
reserve level
Federal Reserve Policy Emphasis
n
n
n
n
Money Supply Growth
Interest Rate Levels
Price Level Changes
Real Economic Activity
Monetary Control Act of 1980
n
To regain more control over the money supply
the MCA required all depository institutions to
l
l
l
n
Meet the same reserve requirements
Hold noninterest-bearing reserves
Promptly report deposit levels to the Fed
Other provision of the MCA allowed all
depository institutions
l
l
To offer transaction accounts
Access to the discount window
Global Monetary Policy
n
n
n
Each country has its own central bank and
often industrialized countries have banks with
similar goals
Integration in the global economy means the
Fed must consider conditions in other
countries when looking at the U.S. economy
Central banks try to work together but
conflicts of interest can make cooperation
difficult at times
Global Monetary Policy
n
A single European monetary policy
l
l
l
l
Euro replaced national currencies of 11 countries
in January 1999
National currencies withdrawn and replaced by
euro by June 1, 2002
Countries of the 15 in the European Union needed
to meet economic criteria and chose to join
Created a European Central Bank