lecture 8 chapter 10: federal reserve. copyright c 2007 by the mcgraw-hill companies, inc. all...
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Lecture 8
Chapter 10: Federal Reserve
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Money and Its Uses
Medium of ExchangeAn asset used in purchasing goods and
services Unit of Account
A basic measure of economic value Store of Value
An asset that serves as a means of holding wealth
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Money and Its Uses
M1Sum of currency outstanding and balances
held in checking accounts M2
All the assets in M1 plus some additional assets that are usable in making payments but at greater cost or inconvenience than currency or checks
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The Composition of Money in the U.S.
Money Supply, M1 (in billions)
Currency (in circulation)Demand depositsOther checkable depositsTraveler’s checks
Total M1
$664312309
8
$1,293
Money Supply, M2 (in billions)
M1Savings deposits a
Small time depositsMoney market mutual funds
Total M2
$1,2933,158
810796
$6,057
$1,293
$6,057
a Including money market deposit accounts. Source: http://www.federalreserve.gov.
The M1 and M2 Money Supply of the U.S –––––––––– (as of December 2003) ––––––––––
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Components of M1 and M2,April 2005 (billions of dollars)
M1
Currency
Demand deposits
Other checkable deposits
Travelers’ checks
M2
M1
Savings deposits
Small-denomination time deposits
Money market mutual funds
1,354.6
704.6
318.5
324.0
7.5
6,469.7
1,354.6
3,544.3
866.2
704.6
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Components of M1 and M2,Feb 2009 (billions of dollars)
M1
Currency
Demand deposits
Other checkable deposits
Travelers’ checks
M2
M1
Savings deposits
Small-denomination time deposits
Money market mutual funds
1,558.3
834.6
397.2
641.8
5.5
8,275.4
1,558.3
4,286.3
1,360.4
1,070.4
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• The banking industry includes:• commercial banks, • savings and loans, and,• credit unions.
The Business of Banking
• Banks are profit-seeking institutions
• Banks play a central role in the capital market (loanable funds market):• They help to bring together people who
want to save for the future with those who want to borrow for current investment projects.
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The Functions of Commercial Banking Institutions
Assets
Vault cash Reserves at the Fed Loans outstanding U.S. govt securities
Other securities Other assets
Total
Checking deposits Savings and time deposits Borrowings Other liabilities Net worth
Consolidated Balance Sheet of Commercial Banking InstitutionsYear-end 2003 (billions of $)
Liabilities
$ 25 9
4,399 1,105
752 1,001
$ 7,291
$ 485 4,117 1,480
679 530
$ 7,291
• Banks provide services and pay interest to attract checking, savings, and time deposits (liabilities).
• Most of these deposits are invested and loaned out, providing interest income for the bank.
• Banks hold a portion of their assets as reserves (either as cash or deposits with the Fed) to meet their daily obligations toward their depositors.
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The Functions of Commercial Banking Institutions
Assets
Non Interest Earning Other Securities Loans outstanding U.S. govt securities Trading AccountOther assets
Total
Checking deposits Savings and time deposits Borrowings Other liabilities Net worth (Capital Acct)
Consolidated Balance Sheet of Commercial Banking InstitutionsYear-end 2007 (billions of $)
Liabilities
$ 1,509 639 6,473
922633 901
$ 11,077
$ 695 4,026 4,755
465 1,136
$ 11,077
• Banks provide services and pay interest to attract checking, savings, and time deposits (liabilities).
• Most of these deposits are invested and loaned out, providing interest income for the bank.
• Banks hold a portion of their assets as reserves (either as cash or deposits with the Fed) to meet their daily obligations toward their depositors.
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• The U.S. banking system is a fractional reserve system; banks are required to maintain only a fraction of their assets as reserves against the deposits of their customers (required reserves).
• Vault cash and the deposits the bank holds with the Federal Reserve count as reserves.
• Excess reserves (actual reserves in excess of the legal requirement) can be used to extend new loans and make new investments.
• Under a fractional reserve system, an increase in deposits will provide the bank with excess reserves and place it in a position to extend additional loans, and thereby expand the money supply.
Fractional Reserve Banking
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Bank
New cash deposits:
Actual Reserves New
Required Reserves
Potential demand deposits created byextending new loans
Initial deposit (bank A) Second stage (bank B) Third stage (bank C) Fourth stage (bank D) Fifth stage (bank E) Sixth stage (bank F) Seventh stage (bank G)
$1,000.00 $200.00 160.00
102.40 81.92 65.54 52.43
800.00 $800.00
512.00 128.00 640.00
640.00 512.00
409.60 409.60
327.68 327.68
262.14 262.14 209.71
Total $5,000.00 $1,000.00 $4,000.00
All others (other banks) 1,048.58 209.71 838.87
Creating Money from New Reserves
• When banks are required to maintain 20% reserves against demand deposits, the creation of $1,000 of new reserves will potentially increase the supply of money by $5,000.
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How Banks Create Moneyby Extending Loans
• The lower the reserve requirement, the greater potential expansion in the money supply resulting from the creation of new reserves.
• The fractional reserve requirement places a ceiling on potential money creation from new reserves.
• Deposit or Money Multiplier = 1/Θ• Θ is ‘reserve requirement’ in decimal form• 1/.2 = 5 for a 20% reserve requirement
• The actual deposit multiplier will be less than the potential because: • Some persons will hold currency rather
than bank deposits. • Some banks may not use all their excess
reserves to extend loans.
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Commercial Banks and the Creation of Money
Bank ReservesCash or similar assets held by commercial
banks for the purpose of meeting depositor withdrawals and payments
100 Percent Reserve BankingA situation in which banks’ reserves equal
100 percent of their deposits
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Commercial Banks and the Creation of Money
AssumeRepublic of Gorgonzola
No banking system Government issues 1 million guilders People want to place their 1 million guilders in a
bank
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Consolidated Balance Sheet of Gorgonzolan Commercial Banks (Initial)
AssetsCurrency 1,000,000 guilders
LiabilitiesDeposits 1,000,000 guilders
Citizens open accounts and deposit 1 million guilders• Deposits are liabilities for the bank• The guilders are an asset for the bank• Guilders are the bank’s reserves• Reserves = deposits: 100 percent reserve bankingReserves are not part of the money supplyDeposits are part of the money supply
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Consolidated Balance Sheet of Gorgonzolan Commercial Banks After One Round of Loans
AssetsCurrency (= reserves) 1,000,000 guilders
Loans to farmers 900,000 guilders
LiabilitiesDeposits 1,000,000 guilders
Fractional Reserve Banking System• Bankers agree they only need a reserve to deposit ratio of 10%• Required reserves = 100,000 guilders, 10% of deposits• Loan out the excess reserves of 900,000 guilders
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Consolidated Balance Sheet ofGorgonzolan Commercial Banks after Guilders Are Redeposited
AssetsCurrency (= reserves)
1,000,000 guilders
Loans to farmers
900,000 guilders
LiabilitiesDeposits 1,900,000 guilders
Loan proceeds are deposited• Reserves = 1,000,000 guilders• Deposits = 1,900,000 guilders• Money supply = 1,900,000 guilders• Reserve to deposit ratio = 52.6% or excess reserves = 810,000• Banks can loan the 810,000 guilders
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Consolidated Balance Sheet of Gorgonizolan Commercial Banks After Two Rounds of Loans and Redeposits
AssetsCurrency (= reserves)
1,000,000 guilders
Loans to farmers
1,710,000 guilders
LiabilitiesDeposits 2,710,000 guilders
Loan proceeds are deposited• Reserves = 1,000,000 guilders• Deposits = 2,710,000 guilders• Money supply = 2,710,000 guilders• Reserve to deposit ratio = 36.9%• Excess reserves = 729,000 guilders
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Final Consolidated Balance Sheet of Gorgonzolan Commercial Banks
AssetsCurrency (= reserves)
1,000,000 guilders
Loans to farmers
9,000,000 guilders
LiabilitiesDeposits 10,000,000 guilders
Observations• Lending will continue until the reserve to deposit ratio = 10%• When loans = 9,000,000 guilders
•Deposits = 10,000,000 guilders•Reserves = 1,000,000 guilders•Reserve to deposit ratio = 10%•No excess reserves
• The money supply = 10,000,000 guilders
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Commercial Banks and the Creation of Money
ObservationsThe use of a fractional-reserve banking
system allows the money supply to grow as a multiple of the reserves
In Gorgonzola, with a 10% reserve-deposit ratio, 1 guilder in reserve can support 10 guilders in deposit.
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Commercial Banks and the Creation of Money
The Money Supply with Both Currency and DepositsGorgonzola residents choose to hold 500,000
guilders as currencyDeposit 500,000 in the banksReserve-deposit ratio = 10%Bank deposits = 500,000/.10 = 5,000,000
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Commercial Banks and the Creation of Money
The Money Supply with Both Currency and DepositsMoney supply = currency + bank deposits
5,500,000 = 500,000 + 5,000,000
The money supply is reduced by 4,500,000 guilders when the residents hold 500,000 guilders in currency
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Commercial Banks and the Creation of Money
The Money Supply at ChristmasCurrency = 500Bank reserves = 500Reserve-deposit ratio = 0.20Money supply = 500 + 500/.20 =
500 + 2,500 = 3,000
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Commercial Banks and the Creation of Money
The Money Supply at Christmas If Xmas shoppers withdraw 100Money supply = 600 + 400/.20
600 + 2,000 = 2,600
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Commercial Banks and the Creation of Money
The Money Supply at ChristmasObservation
When the reserve-deposit ratio = 0.20, every $1 reduction in reserves may reduce the money supply by $5.
In general, when people make withdraws, the money supply contracts by a multiple of the withdrawal.
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The Federal Reserve System
Two Main ResponsibilitiesMonetary policyOversight and regulation of financial markets
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The Federal Reserve System
The History and Structure of the Federal Reserve SystemFounded by the Federal Reserve Act of 1913The primary mission of the Fed is to promote
economic growth, low inflation, and stable financial markets.
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The Federal Reserve System
The Structure12 regional Federal Reserve banks
Assess economic conditions in their regions to assist in national policymaking
Provide service to the commercial banks in their districts
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Philadelphia3SanFrancisco
12
1 Boston
4
Cleveland9
Minneapolis
11
Dallas
Washington, D.C. (Board of Governors)10
Kansas City
7
Chicago
5 Richmond
2 New York
Atlanta6
St. Louis
8
The Federal Reserve Districts
• The map indicates the 12 Federal Reserve districts and the cities in which the district banks are located.
• Each district bank monitors the commercial banks in their region and assists them with the clearing of checks.
• The Board of Governors of the Federal Reserve System is located in Washington D.C.
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The Federal Reserve System
The StructureBoard of Governors
Seven governors Appointed by the president and confirmed by the Senate
to 14 year staggered terms
Chairman of the Board of Governors Selected by the president from the governors Serves a four year term
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The Federal Reserve System
The StructureFederal Open Market Committee (FOMC)
Members include: The seven Fed governors President of the New York Fed Four presidents, chosen on a rotating basis, from the
remaining Federal Reserve Banks
Determines monetary policy
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2008 Members of the FOMC
There are only 10 people listed… as there are only currently 5 Board members due to resignations.
Ben S. Bernanke, Board of Governors, ChairmanDonald L. Kohn, Board of GovernorsRandall S. Kroszner, Board of GovernorsFrederic S. Mishkin, Board of GovernorsKevin M. Warsh, Board of Governors
Timothy F. Geithner, New York, Vice ChairmanRichard W. Fisher, DallasSandra Pianalto, ClevelandCharles I. Plosser, PhiladelphiaGary H. Stern, Minneapolis
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2009 Members of the FOMC
There are only 10 people listed… as there are only currently 5 Board members due to resignations.
Ben S. Bernanke, Board of Governors, Chairman Elizabeth A. Duke, Board of Governors Donald L. Kohn, Board of Governors Daniel K. Tarullo, Board of Governors Kevin M. Warsh, Board of Governors William C. Dudley, New York, Vice Chairman Charles L. Evans, Chicago Jeffrey M. Lacker, Richmond Dennis P. Lockhart, Atlanta Janet L. Yellen, San Francisco
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Press Release
Release Date: March 18, 2009 For immediate release
Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession. Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.
In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.
In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets. The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of evolving financial and economic developments.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
2009 Monetary Policy Releases
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The Public: Households & businesses
Commercial BanksSavings & Loans
Credit UnionsMutual Savings Banks
The Federal Reserve System
• The Board of Governors is at the center of Federal Reserve operations.
• The board sets all the rates and regulations for the depository institutions.
• The seven members of the Board of Governors also serve on the Federal Open Market Committee (FOMC).
• The FOMC is a 12-member board that establishes Fed policy regarding the buying and selling of government securities.
Federal ReserveBoard of Governors
7 members appointed by the president,with the consent of the U.S. Senate
12 Federal ReserveDistrict Banks
(25 branches)
Open MarketCommittee
Board of Governors &5 Federal Reserve Bank Presidents (alternating terms, New York Bankalways represented).
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The Federal Reserve System
Controlling the Money Supply: Open-Market OperationsThe primary function of the Fed is monetary
policy.The Fed controls the money supply by
changing the supply of bank reserves.
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The Federal Reserve System
Controlling the Money Supply: Open-Market OperationsOpen-market operations are the most
important method of changing the supply of bank reserves.
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The Federal Reserve System
Increasing The Money SupplyThe Fed purchases government bonds from
the public.The people deposit the funds they get from
their sale of bonds to the Fed.The increase in deposits increase bank
reserves.
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The Federal Reserve System
Increasing The Money SupplyThe increase in reserves will lead to an
expansion of the money supply as banks make more loans.
Recall The change in the money supply is a multiple of
the change in reserves.
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The Federal Reserve System
Reducing The Money SupplyThe Fed sells government bonds to the
public.The Fed presents the checks from the sale of
the bonds to the banks for payment.
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The Federal Reserve System
Reducing The Money SupplyThe bank’s reserves will fall when they clear
the checks.The money supply will fall by a multiple of the
decrease in reserves.
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The Federal Reserve System
Open-Market PurchaseThe purchase of government bonds from the
public by the Fed for the purpose of increasing the supply of bank reserves and the money supply
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The Federal Reserve System
Open-Market SaleThe sale by the Fed of government bonds to
the public for the purpose of reducing bank reserves and the money supply
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The Federal Reserve System
Open-Market OperationsOpen-market purchases and open-market
sales
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The Federal Reserve System Example
Increasing the money supply by open-market operations
Currency = 1,000 shekels Reserves = 200 Reserve-deposit ratio = 0.2
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The Federal Reserve System Example
Increasing the money supply by open-market operations
Money supply = 1,000 + 200/0.2 = 2,000 shekels Open market purchase = 100 Reserves increase to 300 Money supply = 1,000 + 300/0.2 = 2,500 shekels
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The Federal Reserve System The Fed’s Role in Stabilizing Financial
Markets: Banking PanicsSuppose:
Depositors lose confidence in their bank. They attempt to withdraw their funds. Bank may not have enough reserves (fractional)
to meet the depositors demand. The bank fails and further erodes depositor
confidence which triggers additional failures.
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The Federal Reserve System The Fed’s Role in Stabilizing Financial
Markets: Banking PanicsThe Fed to the rescue:
Instill confidence Discount lending Open Market Operations
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The Federal Reserve System Economic Naturalist
The banking panics of 1930 - 1933 and the money supply
One-third of U.S. banks closed Depositors withdrew their funds Banks raised the reserve-deposit ratio
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Key U.S. MonetaryStatistics, 1929-1933
Currency Reserve-deposit Bank Moneyheld by public ratio reserves supply
December 1929 3.85 0.075 3.15 45.9
December 1930 3.79 0.082 3.31 44.1
December 1931 4.59 0.095 3.11 37.3
December 1932 4.82 0.109 3.18 34.0
December 1933 4.85 0.133 3.45 30.8
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Fed Independence
Long tenure for members of the Board of Governors.Staggered appointments
Bank Presidents appointed to 5-year term by Bank’s Board of DirectorsBoard of Directors selected by bank members
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Funding of the Federal Reserve
The Fed is structured to be self-sufficient in the sense that it meets its operating expenses primarily from the interest earnings on its portfolio of securities. Therefore, it is independent of Congressional decisions about appropriations.
Fed refunds Treasury most of interest each year the money that is collected in the form of interest.
Federal reserve banks owned by domestic banks.
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How the Fed Controls the Money Supply
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The Three Tools the Fed Uses to Control the Money Supply
• The Fed has three major tools that it can use to control the money supply:• Reserve requirements
– setting the fraction of assets that banks must hold as reserves (vault cash or deposits with the Fed), against their checking deposits,
• Open market operations – the buying and selling of U.S. government securities in the open market, and,
• Discount rate – setting the interest rate at which it loans funds to commercial banks and other depository institutions.
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Controlling the Money Supply:Setting Reserve Requirements
• Reserve requirements:a percent of a specified liability category (for example checking deposits) that banking institutions are required to hold as reserves against that type of liability. • When the Fed lowers the required
reserve ratio, it creates excess reserves for commercial banks allowing them to extend additional loans, expanding the money supply.
• Raising the reserve requirements has the opposite effect.
• The Chinese central bank has used this instrument recently.
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Controlling the Money Supply:Open Market Operations
• Open Market Operations:the buying and selling of U.S. Treasury bonds by the Fed.• This is the primary tool used by the
Federal Reserve to control the money supply.
• Note: the U.S. Treasury bonds held by the Fed are part of the national debt.
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Controlling the Money Supply:Open Market Operations
• Open Market Operations:the buying and selling of U.S. Treasury bonds by the Fed.
• When the Fed buys bonds … the money supply expands because:
• bond buyers acquire money• bank reserves increase, placing banks
in a position to expand the money supply through the extension of additional loans
• When the Fed sells bonds …the money supply contracts because:
• bond buyers give up money for securities• bank reserves decline, causing them to
extend fewer loans
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The Federal Reserve System
Increasing The Money SupplyThe Fed purchases government bonds from
the public.The people deposit the funds they get from
their sale of bonds to the Fed.The increase in deposits increase bank
reserves.
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Federal Reserve System
Increasing The Money SupplyThe increase in reserves will lead to an
expansion of the money supply as banks make more loans.
Recall The change in the money supply is a multiple of
the change in reserves.
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The Federal Reserve System
Reducing The Money SupplyThe Fed sells government bonds to the
public.The Fed presents the checks from the sale of
the bonds to the banks for payment.
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The Federal Reserve System
Reducing The Money SupplyThe bank’s reserves will fall when they clear
the checks.The money supply will fall by a multiple of the
decrease in reserves.
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The Federal Reserve System Example
Increasing the money supply by open-market operations
Currency = 1,000 shekels Reserves = 200 Reserve-deposit ratio = 0.2
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The Federal Reserve System Example
Increasing the money supply by open-market operations
Money supply = 1,000 + 200/0.2 = 2,000 shekels Open market purchase = 100 Reserves increase to 300 Money supply = 1,000 + 300/0.2 = 2,500 shekels
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Controlling the Money Supply:The Discount Rate
• Discount Rate:the interest rate the Fed charges banking institutions for borrowed funds
• The discount rate is closely related to the interest rate in the federal funds market, a private loanable funds market where banks with excess reserves extend short-term loans to other banks trying to meet their reserve requirements.• The interest rate in this market is called
the federal funds rate.
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Controlling the Money Supply:The Discount Rate
• Under the operating procedures adopted in 2003, the Fed now charges most banks a discount rate that is slightly higher than the federal funds rate.
• If the Fed wanted to reduce the supply of money it would increase the differential between the discount and federal funds interest rates.
• A decrease in the differential would have the opposite affect.
• Recently the Fed reduced the differential between the discount and federal funds rate
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How the Fed Controls the Federal Funds Rate
• Announcements after the regular meetings of the Federal Open Market Committee often focus on the Fed’s target for the fed funds rate.
• The Fed controls the federal funds rate through open market operations.• The Fed can reduce the fed funds rate by
buying bonds, which will inject additional reserves into the banking system.
• The Fed can increase the fed funds rate by selling bonds, which drains reserves from the banking system.
• Thus, though the media often focuses on the Fed’s target fed funds rate, the Fed is still using open market operations to influence this rate and control the money supply.
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• The Federal Reserve:• is concerned with the monetary climate for
the economy • does not issue bonds• determines the money supply — primarily
through its buying and selling of bonds issued by the U.S. Treasury
The Functions of the Fed and Treasury
• The U.S. Treasury:• is concerned with the finance of the federal
government• issues bonds to the general public to finance
the budget deficits of the federal government• does not determine the money supply
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Aggregate Reserves or the Monetary Base Recent Fed actions of quantitative easing
have led to a spike in the monetary base that has not been seen before
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Monetary Base By Month
0
200000
400000
600000
800000
1000000
1200000
1400000
1600000
1800000 1
959-
Jan.
196
0-A
ug.
196
2-M
ar.
196
3-O
ct.
196
5-M
ay
196
6-D
ec.
196
8-Ju
ly
197
0-F
eb.
197
1-S
ep.
197
3-A
pr.
197
4-N
ov.
1
976-
June
197
8-Ja
n.
197
9-A
ug.
198
1-M
ar.
198
2-O
ct.
198
4-M
ay
198
5-D
ec.
198
7-Ju
ly
198
9-F
eb.
199
0-S
ep.
199
2-A
pr.
199
3-N
ov.
1
995-
June
199
7-Ja
n.
199
8-A
ug.
200
0-M
ar.
200
1-O
ct.
200
3-M
ay
200
4-D
ec.
200
6-Ju
ly
200
8-F
eb.
Month
Mill
ion
s
Series1
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Federal Reserve Note
Money gets into the economy through member banks drawing down their Reserve account, in exchange for an equal amount of currency.
Printed by the Bureau of Engraving and Printing
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Money and Prices
VelocityA measure of the speed at which money
changes hands in transaction involving final goods and services
stockMoney
GDP Nominal
stockMoney
nstransactio of Value Velocity
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Money and Prices
VelocityA measure of the speed at which money
changes hands in transaction involving final goods and services
M
x YP
supply)(money M
GDP) (real x Y level) (price P (V)Velocity
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Money and Prices
Velocity in 2004M1 = $1,367.3 billionM2 = $6,428.4 billionNominal GDP = $11,734.3 billion
8.58 billion $1,367.3
billion $11,734.3 V M1,
1.83 billion $6,428.4
billion $11,734.3 V M2,
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Money and Prices
Velocity in 2008 (averaged monthly data)M1 = $1,424 billionM2 = $7,726.9 billionNominal GDP = $14,264.6 billion
10.01 billion $1,424
billion $14,264.6 V M1,
1.85 billion $7,726.9
billion $14,264.6 V M2,
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Money and Prices
Money and Inflation in the Long RunRecall
M
Y x P V
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Money and Prices
Money and Inflation in the Long RunQuantity equation
M x V = P x Y
Assume V & Y are constant over the time period
Y x P V x M
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Money and Prices
Money and Inflation in the Long Run If the Fed increases M by 10%, then prices
must increase by 10%.High rates of money growth are associated
with high rates of inflation (too much money chasing too few goods).
Y x P V x M