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					               Tools of Monetary Policy
• Open market operations
• Discount rate borrowed reserves
  – LENDER OF LAST RESORT
• Reserve requirements
  – Affect the money multiplier…don’t touch/don’t matter
• Federal funds rate—the interest rate on overnight
  loans of reserves from one bank to another
  – Primary indicator of the stance of monetary policy
      Determined by Supply and Demand reserves
• As federal funds rate decreases,
  …the opportunity cost of holding excess reserves falls
  … the quantity of reserves demanded rises
           Downward sloping demand curve
Supply of reserves by Fed: Nonborrowed + borrowed reserves
      Cost of borrowing from the Fed is the discount rate
     •If iff < id, banks won’t borrow from the Fed;
           • Borrowed reserves are zero  Supply curve is vertical
     •As iff rises above id, banks will borrow more and more at id
     • The supply curve is horizontal (perfectly elastic) at id
Demand for reserves by banks:
      •Banks will hold any amount of excess reserves at ier
          BuyEaseSellTighten
• Open market purchase federal funds rate
  falls
• Open market sale  federal funds rate rises
• Impact of discount rate on federal funds rate
• Impact of reserve requirement on federal funds
  rate
Response to an Open Market Purchase
Response to a Reduction in the Discount Rate
Response to a Change in Required Reserves
            Open Market Operations
• Dynamic open market operations
• Defensive open market operations
   – Repurchase agreements
   – Matched sale-purchase agreements
• TRAPS (Trading Room Automated Processing System)
• Primary dealers

        Advantages of Open Market Operations
•The Fed has complete control
•Flexible and precise
•Easily reversed
•Quickly implemented
               Discount Policy
Primary credit—standing lending facility
• Secondary credit
• Seasonal credit
• Lender of last resort to prevent financial panics …
  moral hazard problem
Cannot be controlled by the Fed;
     the decision maker is the bank
Discount facility keeps the federal funds rate
from rising too far above the target
          Reserve Requirements
• No longer binding for most banks
• Can cause liquidity problems
• Increases uncertainty
• Recommendations to eliminate
How the Federal Reserve’s Operating Procedures
  Limit Fluctuations in the Federal Funds Rate

				
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posted:4/28/2013
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