Module 12: Monetary Policy

Chapter 14 and 15 McGraw Hill

What are the three main functions of Money ?

1.) Medium of Exchange

2.) Unit of Account

3.) Store of Value:

WHat is a medium of Exchange?

acceptable currency at all or nearly all establishments in order to avoid the hassle of barter

What is a unit of account?

a universal medium of value that other goods can be compared with to establish relative worth

What is a store of Value?

asset that has lasting properties in order to be carried into the future

What does the Liquidity of an Asset mean ?

essentially the ease in which an asset can be converted to bills, coins or cash balances

What forms can assets be held in

Stocks, bonds, real estate, collectibles such as comic books or trading cards

Money is the most liquid asset. True or False

True

What is another name of the Money Supply in the US

M1

WHat does M1 consist of

currency

checkable deposits @ commercial banks

Liquid deposits at credit unions

thrift institutions

savings @ commercial banks

What is excluded from M1 and why

Currency held at US treasury, federal reserve, commercial banks etc. Government deposits are also excluded We do not include this currency in M1 to avoid the issue of overcounting. Also to better asses what is available for the private sector

What is a major component of the money supply

Debts and promises to pay

Does paper money have any intrinsic value ?

No

What gives Money its Value ?

Acceptability : Currency is money because people ACCEPT it as money

Legal Tender : backed up by government ex) This note is legal tender for all debts, public, and private

Relative Scarcity: Money drives value from scarcity

Who are money authorities?

members of the board of governors of the federal Reserve System

How many banks are within the Federal Reserve?

12 Banks which control lending activities of nations banks and thrift institution

List the order of chain of command of the Federal reserve Bank

BOard of governors

Federal Open Market committee

12 Federal Reserve Bank

commercial and thrift institutiosn

The Public

How long is a board of governors term

14 years meant outlive political climate

WHat are the 12 banks chartered by the US government

They act as the central banks of the US in charge of setting monetary policy and regulating private bankin system

Each of the 12 banks is a quasi-public bank t/f

True they are also referred to as Bankers Bank

What is a Quasi Public?

The Federal Reserve is a mix of public and private elements. Each of the 12 regional Fed banks is owned by local commercial banks, which must buy stock in their regional Fed bank to be federally chartered.

However, this ownership doesn't give them control—policy decisions are made by the Board of Governors, a public body. Although the Fed banks are privately owned,

they don't operate for profit and often have different priorities than commercial banks

WHat is the role of the Banker Banks of the federal reserve

The Fed performs the actions that a commercial bank would provide for
consumers, only for those commercial banks instead.

They accept deposits and
make loans just as any other bank would.
Commercial banks and thrift institutions deposit funds into Fed banks, which is
then referred to as “reserve balances.”
CAN ISSUE CURRENCY Congress has authorized the Federal Reserve to issue Federal Reserve
notes, which constitutes the nations paper money supply.

What is the FOMC

Federal Open Market Committee .

comprised of 12 people

These individuals meet regularly to determine the open market sales of
government securities (bills, notes, bonds)

What are some functions/ responsibilities of the Federal Reserve

- Issuing currency

- Holding reserves and setting reserve requirements

- Lending to financial institutions and acting as “lender of last resort”

- Providing for check collection

- Acting as the federal fiscal agent.

- Supervising banks

- Controlling the money supply

How does the Fed act as Federal Fiscal Agent?

collects funds through taxation

spends on goods and service

sells and buys bonds

WHat is the dual mandate of the Federal Reserve

1.) FULL EMPLOYMENT

2.) STABLE PRICE LEVEL

Why is the fed independence important to health of economy

The main purpose of doing so was to insulate the firm responsible for monetary

policy from political pressures.

Pressures from lobbyists, special interest groups, and even politicians on

congress and the executive branch will often result in inflationary policy.

An independent monetary authority can take actions otherwise perceived as

unpopular but necessary without fear of reprisal.

What are the three main tools of Monetary Policy the fed has

1) open market operation selling and buying of bonds

2.) changing the interest rate

3) forward guidance (communication to public)

What are the three administered interest rates the Fed takes care of

The 3 administered rates are:

1. Interest rate on reserve balances

2. Overnight reverse repo rate

3. The discount rate

What id the ON RRP

The Fed borrows money for one night from financial companies that aren't banks (like money market funds).

In return, the Fed sells a Treasury bond and promises to buy it back the next day at a higher price—this is how the lender earns interest.

Since the Fed can’t directly pay interest to non-banks, this method gives them a safe way to earn interest overnight.

The ON RRP sets a minimum interest rate for short-term loans in the market, helping the Fed control overall interest rates

WHat is the interest rate on reserve Balances?

• The Fed pays interest to commercial banks for the money (reserves) they keep at any of the 12 regional Fed banks.

• This interest rate is called the IORB.

• By setting the IORB, the Fed influences overall interest rates in the economy.

• Example: If the IORB is 2%, banks won’t want to make loans or investments that earn less than 2%, since they can earn that much safely from the Fed.

• This tool helps the Fed guide the economy and manage inflation.

• Important note: Money held as reserves at the Fed is not circulating, so the IORB also affects the money supply

WHat is discount rate

The Discount Rate – In Simple Terms

• This is the interest rate the Fed charges banks when they borrow money directly from the Fed.

• Unlike IORB and ON RRP (where the Fed borrows), the Discount Rate is for when banks borrow from the Fed.

• backed up by collateral