Federal reserve
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Federal Reserve. Economics 71a Spring 2007 Mayo, Chapter 5 (skim) Lecture notes 2.5. Federal Reserve. Goals Stable prices Full employment Growth Tools Monetary policy Bank regulation. Money Growth and Inflation “Why monetary policy is tricky”. (Money growth) > (Economic growth)

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Federal reserve

Federal Reserve

Economics 71a

Spring 2007

Mayo, Chapter 5 (skim)

Lecture notes 2.5


Federal reserve1

Federal Reserve

  • Goals

    • Stable prices

    • Full employment

    • Growth

  • Tools

    • Monetary policy

    • Bank regulation


Money growth and inflation why monetary policy is tricky

Money Growth and Inflation“Why monetary policy is tricky”

  • (Money growth) > (Economic growth)

    • Inflation

  • (Money growth) < (Economic growth)

    • Deflation

  • Getting this right is tricky


The federal reserve and the money supply

The Federal Reserve and the Money Supply

  • The Fed does not set the money supply

  • Indirect tools

    • Reserve requirements

    • Discount rate

    • Open market operations

  • All are only indirect


Reserve requirements

Reserve Requirements

  • Deposit $100 in bank

    • Bank must keep % (reserve) in vault

    • Loans out rest

    • Example 10%: Keep $10 (reserve), loan $90

  • This $90 ends up at another bank

    • Keep $9, loan $81

  • Money multiplier

  • Reducing the reserve requirement has big positive impact on the money supply

  • Rarely done


Discount rates

Discount Rates

  • Banks can borrow reserves from the Fed

  • Interest rate Fed charges banks is called the discount rate

  • Reducing this increases reserves and also the money supply

  • Federal funds rate

    • Related interest rate

    • Interest banks charge eachother (bank to bank)

  • Only discount rate is set by Federal Reserve


Open market operations

Open Market Operations

  • Federal reserve buys and sells government securities

  • Purchasing government bonds

    • Increases money supply

    • Reduces interest rates

  • Selling government bonds

    • Decreases money supply

    • Increase interest rates


How does this market work

How Does this Market Work?

  • Treasury bill (Tbill)

    • Treasury bill pays $102 in 90 days

    • Price today is $100

    • Interest = 2%

  • Federal reserve starts buying

    • Price goes up to $101

    • Interest (102-101)/101 = approx 1%


Monetary targets

Monetary Targets

  • Money supply

  • Interest rates

  • Inflation rates


The federal reserve and financial markets

The Federal Reserve and Financial Markets

  • Not really in its jurisdiction

  • Clearly linked to banking and monetary system

  • Should the Federal Reserve care about what is going on in other financial markets?

  • Can movements in other markets impact the “money supply”? (Stock market, Real estate)

  • Federal Reserve does worry about systemic risk


Summary

Summary

  • Monetary policy is difficult

  • Tools are not precise

    • Don’t get to set the money supply

  • Interactions with financial markets (both local and globally) are important


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