Concepts - ECON 2035 Exam 3

How many federal reserve districts are there?

12

member banks:

own stock in their district bank

elect directors: 3 "A","B","C"

"A" Directors

represent banking industry

"B" Directors

represent non-banking industry of region

"C" Directors

appointed by board of governors

5 duties of fed banks:

clear checks

manage currency

discount lending

research

presidents serve on FOMC meetings

__ banks are required to be member banks, __ banks can choose

national, state

____ banks must keep reserves with the fed

all

i^oer

interest rate on excess reserves

where is the board of governors located?

Washington DC

How many members are on the board of governors

7

terms of board of governors

14 years

chairman of the board of governors

jerome powell

4 old tools of monetary policy

conduct open market ops

set discount rate

set required reserve ratio

set interest rate on excess reserves

how fed handles external pressure

independent:

nonrenewable long terms helps resist political pressure

independent revenue helps resist external pressure

external pressure on fed

president picks board of governors and chairman

congress legislates structure

arguments for fed reserve independence

monetary policy too important to be left to politicians

avoids political business cycle

arguments against fed reserve independence

undemocratic

How many members are in the FOMC

12 (7 BoG, 5 dist. bank pres.)

The 3 data access books

Green, Blue, Beige

Green Book

national economic forecast for next 2 years, prepped by BoG

Blue Book

projection of monetary aggregates, provides context for monetary policy actions, prepped by BoG

Beige Book

summaries of econ conditions for each district, prepped by district banks

Fed reserve assets

securities (bonds)

discount loans

Fed reserve liabilities

currency - gen pub holding cash

reserves - banks holding cash

balances of bank deposits

Monetary Base =

Currency + Reserves

(MB=C+R)

Borrowed Reserves + Non-borrowed Reserves

(MB=BR+Bnon)

Open market purchase

fed purchases bonds, MB inc by size of purchase

Open market sale

fed sells bonds, MB dec by size of sale (reserves dec if sold to a bank, currency dec if sold to public)

When Fed extends a discount loan to a bank

reserves inc by size of loan, MB inc by size of loan

When Fed calls in a discount loan to a bank

reserves dec by amount repaid, MB dec by amount repaid

Non-borrowed MB

open market ops (OMO)

Borrowed Reserves

discount loans

simple deposit multiplier

required res ratio = required reserves / deposits

rr = RR/dep

R=RR

R=rr*dep

Money Supply =

money multiplier * monetary base

m*MB

money multiplier =

1/req res ratio

1/rr

what is the fed's dual mandate?

price stability

high employment/low unemployment

types of unemployment

frictional

structural

cyclical

frictional unemployment

worker has a skill set that employers need, just has to find a job (short term) (good)

structural unemployment

worker has a skill set that employers don't need (mis-match), chronic and long term (bad, inevitable)

cyclical unemployment

worker unemployed because of a recession (ugly)

Full employment / Natural rate of unemployment

no one is cyclically unemployed

other goals of monetary policy

economic growth - real output inc over time, inc standard of living

stability of financial markets and institutions - should fed "pop" bubbles? can only inc int rate which could push into a recession

interest rate stability - makes investment decisions easier

foreign exchange market stability - stable dollar makes it easier to buy/sell/invest abroad

3 new monetary policy tools

interest rate on excess reserves (i^oer)

Overnight reverse repurchase agreement facility

Term deposit facility

Overnight reverse repurchase agreement facility

fed borrows from a financial firm and uses a security as collateral. usually gets repaid w/in short amt of time with int. - int rate is called ON RRP - overnight reverse repurchase int rate

Term deposit facility

allows banks to purchase term deposits (like CDs) at an int rate determined at an auction

What do open market purchases do?

inc amount of res available, reduce borrowing in fed funds market, dec i^ff

What do open market sales do?

dec amount of res available, inc borrowing in fed funds market, inc i^ff

Discount rate (i^d)

acts as a penalty, usually = i^ff +1%

what does increasing the req res ratio do?

forces banks to hold more reserves, inc borrowing in fed funds market, i^ff inc

what does decreasing the req res ratio do?

banks don't need as many reserves, dec borrowing in fed funds market, i^ff dec

Dynamic Open Market Ops

intended to change monetary policy as directed by FOMC

Defensive Open Market Ops

intended to offset temporary fluctuations in demand/supply of reserves

Benefits of OMO

flexible, easily reversible, fast

Quantitative Easing

When in Dec '08, the fed bought $1.7T of mortgage backed securities & long term treasury bonds to reduce mortgage and long term int rates

Operation Twist

In Sept '11, the fed sold $400b of short term bonds (to raise ST int rate) and bought $400b of long term bonds (to raise LT int rate). MB unchanged

The 2 types of policy lag

Informational

Impact

Informational Lag

the time it takes for policy makers to obtain data indicating what's happening in the economy

Impact Lag

The time it take for policy to actually have an impact on the economy

Intermediate Targets

either monetary aggregates (M1/M2) or int rates. choose target that'll directly help to achieve goal. Fed doesn't directly control these measures; banks, households, and firms have influence

Policy Instruments

closely related to intermediate targets, variable the fed can directly control (fed funds rate on non borrowed reserves)

Taylor Rule

target fed funds int rate = current inflation + real fed funds rate + half of the inflation gap + half of the output gap

i^ff tgt = pi^current + real FF + .5(pi^current-pi^tgt) + .5(y^current-y*)

y* = potential output/full employment output

if output gap is positive, there is an

expansion

if output gap is negitive, there is an

recession

Real GDP (Y)

value of goods & svcs produced

Aggregate Expenditure (AE)

value of total spending in the econ

Aggregate Expenditure (AE) =

Consumption (spending by households) + Investment + Government spending + Net Exports

= C+I+G+NX

Equilibrium occurs when AE =

Y

If AE

inventory inc (overproduction -> excess goes to inventory)

cut back on production -> Y dec until Y=AE

If AE>Y then:

inventory dec

inc production to inc Y until Y=AE

Consumption function

C=mpc*Y

AE formula w/ consumption function

(mpc*Y) + I + G + NX

Phillips Curve

represents the negative relationship between inflation rates and unemployment rate

Phillips Curve Equation

pi = pi^expected + a(U-U*) - S

Expectations of inflation (pi^e)

impacts actual inflation

Unemployment gap

(U-U*)

when U>U*, there's slack in the labor market

Supply Shocks (S)

an adverse supply shock will shift PC up