chapter 5 the federal reserve the federal reserve system tools of monetary policy the federal...
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Chapter 5 The Federal ReserveChapter 5 The Federal ReserveChapter 5 The Federal ReserveChapter 5 The Federal Reserve
• The Federal Reserve System
• Tools of Monetary Policy• The Federal Reserve System
• Tools of Monetary Policy
I. The Federal Reserve SystemI. The Federal Reserve SystemI. The Federal Reserve SystemI. The Federal Reserve System
• “the Fed”
• originally a lender of last resort to prevent bank panics
• today, also conducts monetary policy
• “the Fed”
• originally a lender of last resort to prevent bank panics
• today, also conducts monetary policy
Fed StructureFed StructureFed StructureFed Structure
• Board of Governors• 7 members, 14 yr. nonrenewable
terms• 1 member is Chair
-- Alan Greenspan (1987)
• Board of Governors• 7 members, 14 yr. nonrenewable
terms• 1 member is Chair
-- Alan Greenspan (1987)
• Regional Banks• 12 districts• FRBNY is most important• perform bank services
• Regional Banks• 12 districts• FRBNY is most important• perform bank services
• FOMC• 12 members
-- Board
-- FRBNY President
-- 4 other district presidents (rotate)• meet every 6 weeks to vote on
monetary policy (FF rate target)• FRBNY implements FOMC votes
• FOMC• 12 members
-- Board
-- FRBNY President
-- 4 other district presidents (rotate)• meet every 6 weeks to vote on
monetary policy (FF rate target)• FRBNY implements FOMC votes
Fed independenceFed independenceFed independenceFed independence
• How?• Fed is self-financing• Fed governors serve long-terms
• Why?• economic vs. political goals• long-term vs. short-term goals
• How?• Fed is self-financing• Fed governors serve long-terms
• Why?• economic vs. political goals• long-term vs. short-term goals
• Fed is NOT completely independent• Fed powers can be limited by
Congress
• Fed is NOT completely independent• Fed powers can be limited by
Congress
II. Tools of Monetary PolicyII. Tools of Monetary PolicyII. Tools of Monetary PolicyII. Tools of Monetary Policy
• reserve requirement• % deposits banks must hold as
cash or Fed deposits• changing this will affect MS but• this is expensive to change, and is
too powerful
• reserve requirement• % deposits banks must hold as
cash or Fed deposits• changing this will affect MS but• this is expensive to change, and is
too powerful
• discount loans• loans from the Fed to banks• Fed can change interest rate or
availability of loans but• most banks do not use them• not very effective in controlling MS
• discount loans• loans from the Fed to banks• Fed can change interest rate or
availability of loans but• most banks do not use them• not very effective in controlling MS
• open market operations• main monetary policy tool• Fed buys/sells Treasuries through
private dealers• in 1998 made $35 billion in profit• FOMC votes on federal funds rate
target• FRBNY sells/buys to meet the
target
• open market operations• main monetary policy tool• Fed buys/sells Treasuries through
private dealers• in 1998 made $35 billion in profit• FOMC votes on federal funds rate
target• FRBNY sells/buys to meet the
target
if Fed BUYS Treasuriesif Fed BUYS Treasuriesif Fed BUYS Treasuriesif Fed BUYS Treasuries
• banks reserves increase,
FF rate decreases• immediately
• other short-term rates fall, MS increases• weeks - months
• economic expansion • 1 year
• banks reserves increase,
FF rate decreases• immediately
• other short-term rates fall, MS increases• weeks - months
• economic expansion • 1 year
Open market reposOpen market reposOpen market reposOpen market repos
• temporary changes in bank reserves
• Repo• Fed buys Treasuries with seller
repurchasing them later• temporary increase in reserves
• temporary changes in bank reserves
• Repo• Fed buys Treasuries with seller
repurchasing them later• temporary increase in reserves
• reverse repo• Fed sell Treasuries and agrees to
repurchase• temporary decrease in reserves
• reverse repo• Fed sell Treasuries and agrees to
repurchase• temporary decrease in reserves
Chapter 6. Monetary PolicyChapter 6. Monetary PolicyChapter 6. Monetary PolicyChapter 6. Monetary Policy
• Goals
• Recent history• Goals
• Recent history
I. GoalsI. GoalsI. GoalsI. Goals
• price stability/low inflation• goal: below 3%• 2003: 1.87% (CPI)
• low unemployment• goal: natural rate (4%?)• 12/03: 5.7%
• price stability/low inflation• goal: below 3%• 2003: 1.87% (CPI)
• low unemployment• goal: natural rate (4%?)• 12/03: 5.7%
• economic growth• % increase in real GDP• goal: 3%• 4th Q 2003: 4% annual rate
• financial market stability• calm investors• intervene if markets “too high” or
“too low”
• economic growth• % increase in real GDP• goal: 3%• 4th Q 2003: 4% annual rate
• financial market stability• calm investors• intervene if markets “too high” or
“too low”
Sometimes goals conflictSometimes goals conflictSometimes goals conflictSometimes goals conflict
• low inflation vs. economic growth
• or
• low inflation vs. financial market stability
• but in 1990s, enjoyed strong growth, low inflation
• low inflation vs. economic growth
• or
• low inflation vs. financial market stability
• but in 1990s, enjoyed strong growth, low inflation
II. Monetary policy in 1990sII. Monetary policy in 1990sII. Monetary policy in 1990sII. Monetary policy in 1990s• Fed targets FF rate
• FOMC votes on FF rate target• current target: 1%
(since 6/2003)
• Fed targets FF rate• FOMC votes on FF rate target• current target: 1%
(since 6/2003)
1990-91 recession1990-91 recession1990-91 recession1990-91 recession
• Fed slow to recognize recession and cut FF rate• ‘90-’92 falls from 8% to 3%
• mild recession, but mild/slow recovery
• Fed slow to recognize recession and cut FF rate• ‘90-’92 falls from 8% to 3%
• mild recession, but mild/slow recovery
1994-951994-951994-951994-95
• FOMC announces FF rate target after meeting
• FF rate target raise 8 times (3-6%)• prevent inflation• surprise to financial markets• “soft landing”
• currency intervention to increase Yen/$
• FOMC announces FF rate target after meeting
• FF rate target raise 8 times (3-6%)• prevent inflation• surprise to financial markets• “soft landing”
• currency intervention to increase Yen/$
1998199819981998
• Russian debt default
• Asian currency crisis
• Fed cuts FF rate
• bailout of LTCM to prevent financial panic
• Russian debt default
• Asian currency crisis
• Fed cuts FF rate
• bailout of LTCM to prevent financial panic
1999199919991999
• increases in FF rate for another “soft landing”
• reversed in 2000 after economy slows
• 3/91 - 3/01• longest U.S. expansion
• increases in FF rate for another “soft landing”
• reversed in 2000 after economy slows
• 3/91 - 3/01• longest U.S. expansion
TodayTodayTodayToday
• FF rate target cut from 6.5% to 1% 2000-03
• Recession 2001 (March-Nov.)• slow recovery, esp. job market
• FOMC has indicated that they will keep FF rate low for now• not worried about inflation
• FF rate target cut from 6.5% to 1% 2000-03
• Recession 2001 (March-Nov.)• slow recovery, esp. job market
• FOMC has indicated that they will keep FF rate low for now• not worried about inflation