Ch. 10 Conduct of Monetary Policy

Flashcards about Monetary Policy

What is the relationship between the Federal Reserve's actions and its balance sheet?

The conduct of monetary policy by the Federal Reserve involves actions that affect its balance sheet (holdings of assets and liabilities).

What is the monetary base?

The sum of the Fed’s monetary liabilities and the U.S. Treasury’s monetary liabilities.

What are reserves in the context of the Federal Reserve?

All bank deposits with the Fed.

What are government securities in the context of the Federal Reserve's balance sheet?

The Fed’s holdings of securities issued by the U.S. Treasury.

What are loans to financial institutions in the context of the Federal Reserve's balance sheet?

Loans to member banks at the current discount rate. These loans are referred to as borrowings from the Fed or borrowed reserves.

What are open market operations?

The central bank’s purchase or sale of bonds in the open market.

Why are open market operations the most important monetary policy tool?

Because they are the primary determinants of changes in reserves in the banking system and interest rates.

What happens to the money supply when the Fed purchases bonds?

It increases.

What happens to the money supply when the Fed makes discount loans?

It increases.

What is the effect of an open market purchase on reserves and deposits in the banking system?

It leads to an expansion of reserves and deposits in the banking system and hence to an expansion of the monetary base and the money supply.

What is the effect of an open market sale on reserves and deposits in the banking system?

It leads to a contraction of reserves and deposits in the banking system and hence to a decline in the monetary base and the money supply.

What happens when a bank repays its discount loan?

The amount of reserves decreases along with the monetary base and the money supply.

What is the federal funds rate?

The interest rate on overnight loans of reserves from one bank to another.

Why is the federal funds rate indicative of the Fed’s stance on monetary policy?

Because it is the interest rate that the Fed tries to influence directly.

What are reserve requirements?

The regulations making it obligatory for depository institutions to keep a certain fraction of their deposits as reserves with the Fed.

What does the demand curve for reserves look like, and why?

The demand curves for reserves slopes downward when the federal funds rate is above the interest rate that is earned on these reserves. If the federal funds rate falls below the interest rate paid on reserves, banks would not lend in the overnight market and just keep on adding to their holdings of excess reserves. The demand curve for reserves becomes flat at .

What is the relationship between Nonborrowed Reserves and Borrowed Reserves with the Quantity of Reserves Supplied?

Quantity of Reserves Supplied = Nonborrowed Reserves (NBR)+ Borrowed Reserves (BR)

What happens to the supply of reserves if the federal funds rate is below the discount rate?

Because borrowing federal funds from other banks is a substitute for borrowing from the Fed, if the federal funds rate is below the discount rate , then banks will not borrow from the Fed. Thus, as long as remains below , the supply of reserves = NBR.

What happens to the supply of reserves if the federal funds rate rises about the discount rate?

If the federal funds rate rises above the discount rate, banks would want to keep borrowing more and more at and then lending out the proceeds in the federal funds market at the higher rate, . Hence, the federal funds rate can never rise above the discount rate, and the supply curve becomes flat at .

What is Market equilibrium?

Market equilibrium occurs when the quantity of reserves demanded equals the quantity supplied, . =

What happens to the federal funds rate when the supply curve initially intersects the demand curve in its downward sloped section in an open market purchase?

An open market purchase causes the federal funds rate to fall

What happens to the federal funds rate when the supply curve initially intersects the demand curve in its downward sloped section in an open market sale?

An open market sale causes the federal funds rate to rise.

What happens to the federal funds rate when the supply curve initially intersects the demand curve on its flat section in an open market purchase?

It remains unchanged.