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Chapter 16 The Structure of Central Banks The Federal Reserve

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Chapter 16 The Structure of Central Banks The Federal Reserve Powered By Docstoc
					Chapter 16: Monetary Policy Tools
 1. The Federal Funds Market and Reserves

Central banks have three primary tools for influencing
                 the money supply

                       Discount
                        loans
                                    Open
           Reserve
                                   market
         requirement
                                  operations

                       Money
                       supply
1. The Federal Funds Market and Reserves



                    The reserve requirement
              works through the money multiplier,
             constraining multiple deposit expansion
                      the larger it becomes.

Central banks today rarely use it because most banks work around
                      reserve requirements.
1. The Federal Funds Market and Reserves



                         Discount loans
           influence the monetary base (MB = C + R).

                     Discount loans depend on
        banks (or non-bank borrowers, where applicable)
              first borrowing, then repaying loans.

     The central bank does not have precise control over MB.
1. The Federal Funds Market and Reserves



                   Open market operations
          influence the monetary base (MB = C + R).

     Open market operations (OMO) are generally preferred.
                  The central bank can easily
            expand or contract MB to a precise level.
    Using OMO, central banks can also reverse mistakes quickly.
1. The Federal Funds Market and Reserves

The Fed Funds Market: banks that need reserves can borrow
   them from banks that hold reserves they don’t need.


                       Fed Funds
                                            Lower rates
                        Market
Overnight bank
  borrowing                                 Higher rates
                      Directly from
                           Fed
                                             More Fed
                                             scrutiny
  1. The Federal Funds Market and Reserves

                If Fed Funds rate < discount rate,
               banks borrow in Fed Funds Market

               If Fed Funds rate > discount rate,
                          Arbitrage:
     Borrow at discount window/Lend in Fed Funds Market

The discount rate sets an upper limit to ff* (the actual Fed Funds
  rate) because no bank would borrow reserves at a higher rate
  in the federal funds market than it could borrow directly from
                             the Fed.
2. Open Market Operations and the Discount Window


     Open market activity decisions: Daily
  FRBNY researches:
  •   The level of reserves
  •   The Fed Funds target
  •   The actual market Fed Funds rate
  •   Expectations regarding float
  •   Treasury activities
  •   Treasury market conditions
       – primary dealers, specialized firms, and banks
2. Open Market Operations and the Discount Window


    Open market activity decisions: Each day,
FRBNY determines buy or sell:
• Outright
   – securities permanently join or leave Fed’s balance
     sheet
• Repo (Repurchase agreement)
   – purchase with a guarantee that seller will
     repurchase
• Reverse repo (matched sale-purchase transaction)
   – sell with guarantee that buyer will resell to Fed
 2. Open Market Operations and the Discount Window


                    Discount window
is today primarily a backup facility used during crises
  when the federal funds market might not function
                        effectively.
As lender of last resort, the Fed has a responsibility to
   ensure that banks can obtain as much as they want
    to borrow provided they can post what in normal
   times would be considered good collateral security.
2. Open Market Operations and the Discount Window


                      Discount window
As lender of last resort, the Fed has a responsibility to ensure
     that banks can obtain as much as they want to borrow
           Provided they can maintain good collateral security


 To ensure that banks do not rely too heavily on the
                   discount window:
• discount rate is usually set a full percentage point
       above ff*, a “penalty” of 100 basis points
   2. Open Market Operations and the Discount Window

                Discount window: Crisis of 2008
Federal Reserve invoked its emergency powers to create additional lending
   powers and programs, including:

• Term Auction Facility (TAF), a “credit facility” that allows depository
  institutions to bid for short term funds at a rate established by auction
• Primary Dealer Credit Facility (PDCF), which provides overnight loans to
  primary dealers at the discount rate
• Term Securities Lending Facility (TSLF) also helps primary dealers by
  exchanging Treasuries for riskier collateral for 28-day periods
• Asset-Backed Commercial Paper Money Market Mutual Liquidity Facility,
  which helps money market mutual funds to meet redemptions without
  having to sell their assets into distressed markets
   2. Open Market Operations and the Discount Window

                Discount window: Crisis of 2008
Federal Reserve invoked its emergency powers to create additional lending
   powers and programs, including:

• Commercial Paper Funding Facility (CPFF) allows the FRBNY, through a
  special purpose vehicle (SPV), to purchase commercial paper (short term
  bonds) issued by non-financial corporations
• Money Market Investor Funding Facility (MMIFF) is another lending
  program designed to help the money markets (markets for short term
  bonds) return to normal
     2. Open Market Operations and the Discount Window


• The financial crisis also induced the Fed to engage in
  several rounds of “quantitative easing” or Large Scale
  Asset Purchases (LSAP)
   – Goals:
      1.   increase the prices of (decrease the yields of) Treasury bonds
           and the other financial assets purchased
      2.   influence the money supply directly.
• Due to LSAP, the Fed’s balance sheet swelled from
  less than a trillion dollars in early 2008 to about 3
  trillion in just a year
  http://www.federalreserve.gov/monetarypolicy/bst_
  recenttrends.htm
  2. Open Market Operations and the Discount Window


The Discount window
is also used to provide
moderately shaky banks
a longer-term source of credit
at an even higher penalty rate
 .5 percentage (50 basis) points
above the regular discount rate.
  3. The Monetary Policy Tools of Other Central Banks


Federal Reserve                 European Central Bank
• Uses Open Market              • Uses Open Market
  Operations (OMO) to             Operations (OMO) to
  manage overnight interbank      manage overnight interbank
  rates                           rates
• Uses outright purchases,      • Uses outright purchases,
  repos, and reverse repos        repos, and reverse repos
• Lends at marginal lending     • Lends at marginal lending
  rates                           rates
• Pays interest on reserves     • Pays interest on reserves

				
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posted:4/24/2013
language:English
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