Chapter 5 The Federal Reserve

1. Chapter 5 The Federal Reserve • The Federal Reserve System • Tools of Monetary Policy

2. I. The Federal Reserve System • “the Fed” • originally a lender of last resort to prevent bank panics • today, also conducts monetary policy

3. Fed Structure • Board of Governors • 7 members, 14 yr. nonrenewable terms • 1 member is Chair -- Alan Greenspan (1987)

4. Regional Banks • 12 districts • FRBNY is most important • perform bank services

6. FOMC • 12 members -- Board -- FRBNY President -- 4 other district presidents (rotate) • meet every 6 weeks to vote on monetary policy (FF rate target) • FRBNY implements FOMC votes

7. Fed independence • How? • Fed is self-financing • Fed governors serve long-terms • Why? • economic vs. political goals • long-term vs. short-term goals

8. Fed is NOT completely independent • Fed powers can be limited by Congress

9. II. Tools of Monetary Policy • reserve requirement • % deposits banks must hold as cash or Fed deposits • changing this will affect MS but • this is expensive to change, and is too powerful

10. discount loans • loans from the Fed to banks • Fed can change interest rate or availability of loans but • most banks do not use them • not very effective in controlling MS

11. open market operations • main monetary policy tool • Fed buys/sells Treasuries through private dealers • in 1998 made $35 billion in profit • FOMC votes on federal funds rate target • FRBNY sells/buys to meet the target

12. if Fed BUYS Treasuries • banks reserves increase, FF rate decreases • immediately • other short-term rates fall, MS increases • weeks - months • economic expansion • 1 year

13. FF rate target, 2000-2003 As FF rate falls, other ST rates also fall

14. Open market repos • temporary changes in bank reserves • Repo • Fed buys Treasuries with seller repurchasing them later • temporary increase in reserves

15. reverse repo • Fed sell Treasuries and agrees to repurchase • temporary decrease in reserves

16. Chapter 6. Monetary Policy • Goals • Recent history

17. I. Goals • price stability/low inflation • goal: below 3% • 2003: 1.87% (CPI) • low unemployment • goal: natural rate (4%?) • 12/03: 5.7%

18. economic growth • % increase in real GDP • goal: 3% • 4th Q 2003: 4% annual rate • financial market stability • calm investors • intervene if markets “too high” or “too low”

19. Sometimes goals conflict • low inflation vs. economic growth • or • low inflation vs. financial market stability • but in 1990s, enjoyed strong growth, low inflation

20. II. Monetary policy in 1990s • Fed targets FF rate • FOMC votes on FF rate target • current target: 1% (since 6/2003)

22. 1990-91 recession • Fed slow to recognize recession and cut FF rate • ‘90-’92 falls from 8% to 3% • mild recession, but mild/slow recovery

23. 1994-95 • FOMC announces FF rate target after meeting • FF rate target raise 8 times (3-6%) • prevent inflation • surprise to financial markets • “soft landing” • currency intervention to increase Yen/$

24. 1998 • Russian debt default • Asian currency crisis • Fed cuts FF rate • bailout of LTCM to prevent financial panic

25. 1999 • increases in FF rate for another “soft landing” • reversed in 2000 after economy slows • 3/91 - 3/01 • longest U.S. expansion

26. Today • FF rate target cut from 6.5% to 1% 2000-03 • Recession 2001 (March-Nov.) • slow recovery, esp. job market • FOMC has indicated that they will keep FF rate low for now • not worried about inflation