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Lecture 14: Monetary Policy

Lecture 14: Monetary Policy

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Lecture 14: Monetary Policy

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  1. Lecture 14: Monetary Policy

  2. Bank of England 1694 • Granted monopoly on joint stock banking by Parliament in return for war loans. • Not an invention of economists, started off as a powerful bank that was able to demand that other banks held deposits in it. • Did not have government monopoly on note issue, but achieved it through its monopoly power.

  3. Banks of the United States • Loosely modeled after Bank of England • First Bank of the United States 1791-1811, was promoted by Alexander Hamilton • Second Bank of the United States 1816-1836. President Andrew Jackson called it a “dangerous monopoly,” conflict with Nicholas Biddle, president. • Suffolk System, Massachusetts

  4. Nineteenth Century Problems and Solutions • Privately issued bank notes • Discounts on notes • Banking panics associated with business depressions • National Banking System, 1863, mostly ended panics until 1907. • 1907 panic saved by J. P. Morgan • Under National Banking System inflexible money supply, strongly seasonal interest rate • Led to creation of Federal Reserve

  5. Federal Reserve System - 1913 • Created flexible money supply, responding to business situation • Fed was lender of last resort • 12 Regional banks, each presides over a district. • Two in Missouri • Board of Governors in Washington DC

  6. Board of Governors • 7 members, 14-year terms • Chairman has 4-year term. Traditional power of the chairman • Independent of executive and legislative branch. An “independent central bank.” • Chairman must make semiannual monetary policy reports (Humphrey Hawkins)

  7. Banking Panic of 1933 • Despite Fed’s lending, a banking panic forced Roosevelt to declare a banking holiday • Led to establishment of Federal Deposit Insurance Company (FDIC) opened doors in 1934, funded by premia paid by banks • No U. S. panics since

  8. European Central Bank • Founded 1998 • Eurozone members and non Eurozone members • Had to construct Eurozone data for first time • President Jean-Claude Trichet since 2003 • Otmar Issing

  9. New Euro Currency • Currency first issued January 1, 2002 • “The parallel lines [in €] “represent the stability of the euro.”

  10. Bank of Japan • Toshihiko Fukui, Governor since 2003 • Interest rates have been brought down virtually to zero • Purchase of government bonds to try to stimulate economy • Proposals to buy foreign bonds, dollars • Japanese banks sitting on unlent funds

  11. Nikkei Index Monthly 1984-I to 2004-II

  12. Monetary Problem in Japan • Inflation often negative • Gensaki rate zero • Real rate often substantial, Bank of Japan can do nothing • Svensson proposal to peg yen at, say, 160 to dollar, unheeded by conservative B of J

  13. Reserve Requirements • Depository Institutions Deregulation and Monetary Control Act of 1980: 12% reserves on demand deposits, 3% on time • Act allows Fed to change reserve requirements, on demand deposits within range 8% and 14%. • Banks must meet requirements over two-week statement period • Reserves are in cash or balances with federal reserve. Fedwire

  14. FOMC • Federal Reserve Board, President of New York Fed, and four other reserve bank presidents. • Meets roughly once a month • Since 1994, has made immediate announcements of policy decision • Since 1997 has made immediate announcements of federal funds rate target

  15. Trading Desk, FRBNY • Buys and sells Treasury bills • August 1999 FOMC gave desk authorization to trade in mortgage-backed securities • FOMC is studying allowing desk to trade in debt of states, or foreign countries.

  16. Discount Rate and Federal Funds Rate • Discount rate is rate on loans Fed makes to member banks. • Borrowing is a privilege, not a right • Federal funds rate is rate of interest banks pay to each other when they lend excess reserves. • Repo rate is collateralized, hence tends to be a little lower.

  17. Changed Definition of Discount Rate • Prior to 2003, discount rate was usually 50 basis points lower than the funds rate • Then, borrowing at discount window carried stigma • On Jan 9, 2003, Fed raised discount rate above funds rate, eliminating stigma • Primary discount rate (sound banks) about 100 basis points above funds rate • Secondary discount rate (banks that do not qualify) 50 points above primary discount rate

  18. Federal Funds Rate and Inflation Rate Monthly 1954-VII to 2004-I

  19. Real Federal Funds Rate Monthly 1954-VII to 2004-I

  20. Stabilization and 1980 and 1981-2 Recessions • New Fed Chairman Paul Volcker thought inflation had gotten out of hand. • Created “the great recession” that stopped inflation • Many foreign countries similar experience

  21. Stabilization and 1990-1991 recession • Fed was misled by inaccurate GDP numbers, didn’t see recession coming. • First started cutting interest rates Dec. 1990, after recession had been on for six months

  22. The 2001 Recession • Not brought on by rising interest rates to curb inflationary pressure • A post-stock-market bubble recession • Dramatic cuts in rates starting early 2001 • Recession short lived (March-November) • Housing boom started by rate cuts