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Activist rule

Activist rule

a rule for monetary policy under which monetary policy is allowed to change over the course of the business cycle####Agents in the Money Supply Process

-banks

-depositors

-borrowers####bank assets include

-bank building & furniture etc

-cash in vault

-deposits at other banks (fed)

-securities (treasury bills, bonds, etc)

-loans####bank liabilities include

-demand deposits (checking accounts)

-various savings accounts

-large certificates of deposits

-other borrowed monies####Benefits of fed transparency

-levels playing field

-makes fed more accountable

-reduces policy lags by cutting recognition lags to zero

-improves transmission of policy via the expectations theory of yield curve

-reduces "liquidity" or "term premiums" embedded in yield curve####Board of Governors of the Federal Reserve System

-The seven-member board that supervises the banking system of the United States

-appointed by president, confirmed by state

-14-year non renewable term

-required to come from different districts

-pres selects chairman, a governor, serves as a four-year renewable term as chair####capital requirement

bank regulators require that banks maintain adequate capital to serve as a buffer against losses####Case against independence

-Unaccountable

-Difficult to coordinate fiscal and monetary policy####defensive open market operations

aimed at offsetting changes in the autonomous reserve factors (those that add or drain reserves) with an intent of getting the funds rate to trade close to target####Duties of the Board of Governors

-Sets reserve requirements

-Controls the discount rate through "review and determination" process

-Sets margin requirements

-Sets salaries of president and officers of each Federal Reserve Bank and reviews each bank's budget

-Approves bank mergers and applications for new activities

-Specifies the permissible activities of bank holding companies

-Supervises the activities of foreign banks operating in the U.S.####dynamic open market operations

aimed at fundamentally changing the funds rate target - Policy Decision####Equation of Exchange

-influences by degree of uncertainty. onset of credit crisis uncertainty rose, so did the demand for excess reserves.

-increase in uncertainty shifts the demand for reserves outward, and unless the supply is increase will cause the funds rate to rise.####factors affecting bank reserves and monetary base

-float

-treasury deposits at the federal reserve

-interventions in the foreign exchange market

-redemptions from fed's portfolio####federal funds market

A market for overnight lending and borrowing of reserves among banks; the market for reserves on account at the FED####federal funds rate targeting

-issue new currency

-withdraw damaged currency from circulation

-administer and make discount loans to banks in their district

-evaluate proposed mergers and applications for banks to expand their activities

-collect data on local business conditions####federal reserve banks and monetary policy

-Directors "establish" the discount rate

-Decide which banks can obtain discount loans

-Directors select one commercial banker from each district to serve on the Federal Advisory Council which consults with the Board of Governors and provides information to help conduct monetary policy

-Five of the 12 bank presidents have a vote in the Federal Open Market Committee (FOMC)####financial intermediaries other than commercial banks

-thrifts (saving institutions)

-mutual funds

-money market funds

-investment banks

-hedge funds

-insurance companies

-structured investment vehicles####FOMC releases

-post meeting statement: afternoon of meeting

-survey of economic projections: afternoon following meeting (4 times per year)

-post meeting press conference following meeting wherein SEP were compiled

-Minutes: 3 weeks after meeting

-transcripts: 5 years after meeting####FOMC- Policy making arm the fed

-meets 8 times a year

-7 members of the board of governors, president of the FRBNY, presidents of four other federal reserve banks

-chariman of the board of governors is also chair of FOMC, president of FRBNY is vice chair of FOMC

-issues directives to the trading desk at the FRBNY- sets Fed Funds Target####fractional reserve banking

a banking system that keeps only a fraction of funds on hand and lends out the remainder####Friedman's Basic Thesis

-in SR, increases in money supply causes employment and output to increase, and decreases in money supply have the opposite effect####Gold Standard

-the value of currency is fixed in terms of quantity of gold

-sets the money supply and price level generally with limited central bank intervention####How do commercial banks make money?

they earn more interest on assets than they pay on liabilities####How high fed become more transparent?

-broadcast FOMC meetings on C-span

-release minutes sooner

-make transcripts with shorter lags

-provide more frequent forecasts####How independent is the Fed?

• Instrument and goal independence

• Independent revenue

• Fed's structure is written by Congress, and is subject to change at any time.

• Presidential influence:

*Influence on Congress

*Appoints members

*Appoints chairman although terms are not concurrent####important characteristics of money

divisibility, portability, stability, durability, difficulty of counterfeiting, scarce####Keynes motives for holding money balances

precautionary motive

speculative motive####Lagged Reserve Accounting (LRA)

renders a disconnect between deposit growth and required reserve####liquidity trap

-Commercial banks chartered by states are not required but may choose to be members

-Depository Institutions Deregulation and Monetary Control Act of 1980 subjected all banks to the same reserve requirements as member banks and gave all banks access to Federal Reserve facilities####Monetarists

economists who believe the velocity of money is fairly constant or predictable####Money and Price level

P=MV/Real GDP####money growth rule

a rule that focuses only on the growth rate of money in the economy; under such a rule, the central bank simply would set money growth in the long run, ignoring short-run fluctuations in the economy####money market instruments

-large negotiable certificates of deposit

-eurodollars

repurchase agreements and reserves RPs

-treasury bills

-commercial paper####National banks

chartered by federal gov (must be members of federal reserve)####New York Clearing house

-"debits" or reduces the account of the payer bank

-"credits" or increases the account of payee bank####nonactivist rule

a rule for monetary policy under which the same monetary policy is pursued whether the economy is in a recession or an expansion (Monetarists believed in this)####open market operations

-sale decreases the volume of bank reserves####Precautionary motive

people prefer to have liquidity incase of unexpected problems: the higher the degree of uncertainty, the greater the demand for precautionary balances####Problems with gold standard

-all countries on gold standard are forced to maintain fixed exchange rates

-the effects of bad policies in one country can be transmitted to other countries

-if not perfectly credible, it is subject to speculative attack and ultimate collapse

-didnt prevent financial panics

-medium run- caused periods of inflation/deflation####Reserve requirements

depository institutions must set aside a % of their deposits as reserves to be held either as cash on hand, or as reserve account - balances at a federal reserve bank####Role of Chairman

-supervises professional economists and advisers

-volcker/greenspan/bernanke/yellen - differences in style####special role of the federal reserve bank of NY (FRBNY)

-executes monetary policy

-agent of the US Treasury conducts US gov financing operations

-executes intervention in foreign market

-provides custody and related services to foreign central banks

-President serves as vice chair of FOMC and permanent voting member

-assumed a number of roles associated with the Fed's crisis related "Credit Policies"####speculative motive

people retain liquidity when interest rates are low and buy bonds when interest rates are high####state banks

2. inject capital to buy building, vault, and to have cash on hand

3. take in deposits

4. make loans####The Fed Controls the Supply of Bank Reserves

-federal reserve determines the supply of bank reserves

-by buying/selling securities. buying = securities shifts supply curve to the right. selling = securities shifts supply curve to the left####The federal reserve system

-headed by board of governors

-12 federal reserve banks located throughout the nation

-US monetary policy determined by the FOMC####the payment system

outside money - created by the gov, coins and federal reserve notes (currency)

-inside money - money created in the private sector, checking accounts, travelers checks, etc####total bank reserves = required reserves + excess reserves

required reserves = reserve ratio X deposits

excess reserves =any reserves above required####Transaction motive

the amount of desired money balances is a function of income: the higher the income, the more money demanded for carrying out increased spending####What determines demand for bank reserves?

-excess reserves = all reserves beyond that required to meet mandated required reserves.####what determines potential gdp?

-growth of the labor force