Topic 6

Question 1

4 conventional monetary policy tools and brief descriptions?

Answer 1

1) target interest rate: the rate one FI lends to another in an overnight sale of balances (decided by CB)
2) discount rate: rate at which banks borrow off CB
3) deposit rate: rate of interest which FIs pay deposit account holders
4) reserve requirements

Question 2

What is the target federal fund rate and how is it determined?

Answer 2

The rate at which US banks lend reserves to each other overnight - a target is set by the FOMC but it is determined by market forces (the prevailing rate is called the MARKET FEDERAL FUNDS RATE)

Question 3

FED: why do banks need to lend to each other?

Answer 3

• banks have target reserves they must meet by the end of each day
• without the reserves market, banks would have to hold substantial quantity of excess resources as insurance for shortfalls
• tf bilateral transaction agreements are needed between banks

Question 4

FED: why must the borrowing bank be considered creditworthy?

Answer 4

Because the loans are unsecured

Question 5

FED: learn diagram showing marker for reserves?

Answer 5

Now

Question 6

Explain the shape of the reserve supply curve?

Answer 6

Vertical portion: banks have target amount of reserves, beyond this they won’t lend regardless of the rate tf supply is fixed

Horizontal portion: at the discount rate the CB steps in and will lend to banks; essentially they will lend an ‘unlimited’ amount at this level tf horizontal supply

Question 7

Explain the shape of the fed reserve demand curve?

Answer 7

Downward sloping: at high rates, less quantity of reserves are demanded and vice versa

Flat: below the deposit rate no quantity of reserves are demanded because banks won’t borrow if it means ???

Question 8

How do the CB keep the target rate?

Answer 8

They buy issued securities back/issue more securities, this changes the supply of reserves tf shifting the supply curve to meet the target rate

Question 9

3 things a CB can control by controlling the quantity of loans made?

Answer 9

Size of reserves
Size of monetary base
Interest rates

Question 10

When is discount lending large?

Answer 10

Only during crisis periods

Question 11

What do the fed use discount lending for?

Answer 11

Ensuring short term financial stability

Eliminating bank panics

Preventing collapse of institutions experiencing financial difficulties

Question 12

What is the role of the federal reserve board?

Answer 12

They set the minimum levels of reserves banks must hold (since 1935)

Question 13

What was the initial reason for reserves?

Answer 13

To assure depositors they could withdraw currency on demand

Question 14

What are the main 2 functions of reserve requirements today?

Answer 14

Stabilise the demand for reserves

To help Fed to keep federal funds rate close to target

Question 15

ECB: what four things are in the ECB’s monetary policy toolbox?

Answer 15

Overnight interbank rate
Rate at which CB lends to commercial banks
Reserve deposit rate
Reserve requirement

Question 16

How does the ECB avoid buying securities outright?

Answer 16

Repurchase agreements

Question 17

Explain how the ECB repo works?

Answer 17

A weekly auction of 2 week repurchase agreements in which the ECB, through other national CBs, provides reserves to banks in exchange for securities

Question 18

What is the minimum interest rate?

Answer 18

The policy tool used by the ECB; the minimum rate refinancing auctions can use

Question 19

In a financial crisis, how might the CB change repos to steady the markets?

Answer 19

They might make them long term refinancing operations

Question 20

Explain what the ECBs marginal lending facility is?

Answer 20

It provides overnight loans to banks if they face a reserve deficiency that they can’t satisfy more cheaply in the market place

Marginal lending rate&raquo_space; target refinancing rate

Question 21

What is the ECBs deposit facility?

Answer 21

The rate the ECB will pay banks for their excess reserves

Deposit facility rate much less than target refinancing rate

Question 22

What is the function of the ECB deposit facility?

Answer 22

It provides a floor on the rate of interest that can be charged on reserves

Question 23

Explain the ECBs reserve requirements?

Answer 23

Minimum level of reserves based on liabilities; ECB pays interest on required reserves

Question 24

How is the rate the ECB pays on reserve requirements determined?

Answer 24

It is based on the monthly average interest rate from refinancing auctions

Question 25

3 differences between the ECBs refinancing operations and the fed's daily OMOs?

Answer 25

Operations are done at NCBs simultaneously Hundreds of European banks participate in the ECBs weekly auctions Accepted collateral varies between CBs due to different financial structures

Question 26

3 consensus estimate among monetary policy experts regarding CB policy?

Answer 26

Reserve requirements not that useful as operational instrument CB lending necessary for financial stability Short term interest rates are a good tool stabilise short term fluctuations in prices and output

Question 27

3 desirable features of a MP instrument?

Answer 27

- easily observable - controllable and quickly changeable - tightly linked to policymakers' objectives

Question 28

Define operating instruments?

Answer 28

Instruments the CB controls directly (eg. Interest rates, monetary base)

Question 29

Define intermediate targets?

Answer 29

Instruments not directly controlled by CB (eg. Growth in monetary aggregates)

Question 30

2 reasons to use unconventional monetary policy?

Answer 30

When lowering the target interest rate to zero doesn't sufficiently stimulate the economy When an impaired financial system -> failure of interest rate policy in supporting the economy (eg. High default rates -> loans not being made)

Question 31

3 types of unconventional monetary policy tools and brief explanation?

Answer 31

Forward guidance: CB communicates intentions regarding future MP Quantitative easing: CB supplies aggregate reserves beyond quantity required to lower policy rate to zero Targeted asset purchases: CB alters mix of assets on the balance sheet to change their relative prices in a way that stimulates economic activity

Question 32

Explain how forward guidance works?

Answer 32

Eg. State aim to keep policy target low for long period -> increased ability of firms to plan -> increased investment -> increased growth

Question 33

3 issues with forward guidance?

Answer 33

Needs to be credible guidance or won't work!!! Can be difficult to calibrate (can't always predict future conditions tf hard to make promises) Can have disturbing side effects

Question 34

Explain how quantitative easing works?

Answer 34

The CB buys assets off banks -> expansion of their balance sheet -> increased reserves for banks -> increased lending (Increases liquidity in commercial banks)

Question 35

3 issues with quantitative easing?

Answer 35

Difficult to predict effects due to little experience; how much to spend? Will banks actually lend? Pension funds notes Raises inflation rate tf can't be used if inf rate > target inf rate

Question 36

Quantitative easing diagram?

Answer 36

Shows supply of reserves going right, check online

Question 37

Explain how TAP might work?

Answer 37

CB buys a risky asset -> credit where there was none before

Question 38

3 issues with TAP?

Answer 38

Harder to sell off risky assets after tf difficult to unwind CB may not be able to get rid of them exactly when they want Also difficult to tell exactly what will happen (risky assets -> defaulting loans etc)

Question 39

How can QE and TAP exits be more effective?

Answer 39

CB will want to sell off assets to increase interest rate, but this can be difficult to do quickly tf CB can raise deposit rate that it pays on reserves tf increase floor of MFFR

Question 40

See: exciting QE by hiking deposit rate diagram

Answer 40

Now

Question 41

Explain why CBs pay interest on reserves?

Answer 41

It allows them to use two powerful policy tools independently of each other: 1) can adjust interbank loans target rate without changing size and composition of its balance sheet 2) can prevent banks from quickly selling all their assets by increasing the deposit rate on reserves CONFUSED