Exam 2 Flashcards
3 monetary policy tools
- Open market operations
- Discount rate
- Reserve requirements
Major link by which monetary policy impacts the macroeconomy
Federal Reserve influencing the market for bank reserves
What does the federal reserve’s monetary policy seek to influence?
The demand for or supply of excess reserves at depository institutions and in turn the money supply and level of interest rates
How do depository institutions trade excess reserves held at their local federal reserve banks?
Among themselves
Fed funds rate
Rate of interest or price on the transactions between depository institutions trading excess reserves between themselves
Financial Services Regulatory Relief Act of 2006
Authorized the federal reserve to pay interest on reserve balances
Two basic approaches to affect the market for banks’ excess reserves
- Target the quantity of reserves in the market
- Target the interest rate on those reserves (the fed funds rate)
open market operations
The Federal Reserve’s purchase or sale of securities in the U.S. Treasury securities market
what happens when a targeted monetary aggregate or interest rate level is determined by the FOMC
forwarded to the Federal Reserve Board Trading Desk at the Federal Reserve Bank of New York through a policy directive
how does the Manager of the Trading Desk use the policy directive
to instruct traders on daily amount of open market purchases or sales to transact
what is the primary determinant of changes in bank excess reserves in the banking system
open market operations
what directly impacts the size of the money supply and or the level of interest rates (fed funds rate)
open market operations
discount rate
second monetary policy tool used by the Fed to control the level of bank reserve or the money supply or interest rates
Raising the discount rate
signals a desire to see a tightening of monetary conditions and higher interest rates in general
Lowering the discount rate
signals a desire to see more expansionary monetary conditions and lower interest rates in general
two reasons the Federal Reserve has rarely used the discount rate as a monetary policy tool
- is difficult for the Fed to predict changes in bank discount window borrowing when the discount rate changes
- Because of its “signaling” importance, a discount rate change often has great effects on the financial markets
three discount lending programs
- Primary credit is available to generally sound DIs on a very short-term basis, typically overnight, at a rate above the Federal Open Market Committee’s target rate for federal funds
- Secondary credit is available to meet backup liquidity needs when its use is consistent with a timely return to a reliance on market sources of funding or the orderly resolution of a troubled institution
- Seasonal credit is available to DIs that can demonstrate a clear pattern of recurring intrayearly swings in funding needs
reserve requirements (reserve ratio)
determine the minimum amount of reserve assets that DIs must maintain by law to back transaction deposit accounts held as liabilities on their balance sheets
A(n) decrease (increase) in the reserve requirement ratio
means that DIs may hold fewer (must hold more) reserves against their transaction accounts, allowing them to lend out a greater (smaller) percentage of their deposits and increasing (decreasing) credit availability in the economy
Decrease in the reserve requirement
results in a multiplier increase in the supply of bank deposits and thus the money supply
Increase in the reserve requirement
results in a multiple contraction in deposits and a decrease in the money supply
three expansionary activities
- Open market purchases of securities
All else constant, reserve accounts of banks increase - Discount rate decreases
All else constant, interest rates in the economy decrease - Reserve requirement ratio decreases
All else constant, bank reserves increase
three contractionary activities
- Open market sales of securities
All else constant, reserve accounts of banks decrease - Discount rate increases
All else constant, interest rates in the open market increase - Reserve requirement ratio increases
All else constant, bank reserves decrease
Federal Reserve can successfully target only one of these two variables at any one moment
money supply or interest rates
If the money supply is the target variable used to implement monetary policy
interest rates must be allowed to fluctuate relatively freely
If an interest rate (e.g., fed funds rate) is the target
bank reserves and the money supply must be allowed to fluctuate relatively freely
Taylor rule
which states short-term interest rates should be determined by three conditions:
1. Where actual inflation is relative to the Fed’s targeted level
2. The extent to which the economy is above or below its full employment level
3. What short-term interest rates should be to achieve full employment
Central banks
guide the monetary policy in virtually all countries
Independence of a central bank
generally means that the bank is free from pressure from politicians who may attempt to enhance economic activity in the short term at the expense of long-term economic growth
Banks with less independence
People’s Bank of China
Reserve Bank of India
Central Bank of Brazil
four systemwide rescue programs employed during the financial crisis
- Expansion of retail deposit insurance was widely used during the crisis to ensure continued access to deposit funding
- Capital injections by central governments were the main mechanism used to directly support bank balance sheets
- Debt guarantees allowed banks to maintain access to reasonably priced, medium-term funding.
They also reduced liquidity risk and lowered overall borrowing costs for banks - Asset purchases/guarantees removed distressed assets from bank balance sheets
The primary policy tool used by the Fed to meet its monetary policy goals is:
a) changing the discount rate
b) changing reserve requirements
c) devaluing the currency
d) changing bank regulations
e) open market operations
e) open market operations
The Fed Funds rate is the rate that:
a) banks charge for loans to corporate customers
b) banks charge to lend foreign exchange to customers
c) the Federal Reserve charges on emergency loans to commercial banks
d) banks charge each other on loans of excess reserves
e) banks charge security dealers to finance their inventory
d) banks charge each other on loans of excess reserves
The discount rate is the rate that:
a) banks charge for loans to corporate customers.
b) banks charge to lend foreign exchange to customers.
c) banks charge each other on loans of excess reserves.
d) banks charge securities dealers to finance their inventory.
e) the Federal Reserve charges on loans to commercial banks.
e) the Federal Reserve charges on loans to commercial banks.
A decrease in reserve requirements could lead to an:
a) increase in bank lending.
b) increase in the money supply.
c) increase in the discount rate.
d) increase in bank lending and an increase in the money supply.
e) increase in bank lending and an increase in the discount rate.
d) increase in bank lending and an increase in the money supply
If the Fed wishes to stimulate the economy, it could:
I. buy U.S. government securities.
II. raise the discount rate.
III. lower reserve requirements.
a) I and III only
b) II and III only
c) I and II only
d) II only
e) I, II, and II
a) I and III only
The Fed offers three types of discount window loans. ______________ credit is offered to small institutions with demonstrable patterns of financing needs, _____________ credit is offered for short-term temporary funds outflows, and _____________ credit may be offered at a higher rate to troubled institutions with more severe liquidity problems.
a) Seasonal; extended; adjustment
b) Extended; adjustment; seasonal
c) Adjustment; extended; seasonal
d) Seasonal; primary; secondary
e) Adjustment; seasonal; extended
d) Seasonal; primary; secondary
Money markets
trade debt securities or instruments with maturities of less than one year
once issued, money market instruments trade in
active secondary markets
why does the need for money markets arise
because the immediate cash needs of individuals, corporations and governments do not necessarily coincide with their receipts of cash
5 basic characteristics of money market instruments
1) Generally sold in large denominations ($1m to $10m units)
2) Issued by high-quality (i.e., low default risk) economic units that require short-term funds
3) Low default risk, the risk of late or nonpayment of principal and/or interest
4) Short maturity - original maturity of one year or less
5) High marketability
6 money market instruments
1) Treasury bills (T-bills)
2) Federal funds (fed funds)
3) Repurchase agreements (repos or RP)
4) Commercial paper (CP)
5) Negotiable certificates of deposit (CD)
6) Banker’s acceptances (BA)
4 money market yields
1) Bond Equivalent Yield
2) Discount Yields
3) Effective Annual Return
4) Single-Payment Yields
bond equivalent yield
the quoted nominal, or stated, yield on a security, the rate used to calculate the PV of an investment
treasury bills (t-bills)
short-term debt obligations issued by the U.S. government to cover government budget deficits and to refinance maturing government debt
