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Chapter 5. CENTRAL BANKS AND THE CREATION OF MONEY. The Federal Reserve System. Board of Governors Federal Reserve Banks Member Banks Federal Open Market Committee. Tools of Monetary Policy. Reserve Requirements Open Market Operations Open Market Repurchase Agreements Discount Rate.

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Chapter 5

Chapter 5

CENTRAL BANKS AND THE CREATION OF MONEY


The federal reserve system
The Federal Reserve System

  • Board of Governors

  • Federal Reserve Banks

  • Member Banks

  • Federal Open Market Committee


Tools of monetary policy
Tools of Monetary Policy

  • Reserve Requirements

  • Open Market Operations

  • Open Market Repurchase Agreements

  • Discount Rate


Reserve requirements
Reserve Requirements

  • Fractional Reserve Banking System

    • Required reserve ratio

      • Demand deposits

      • Time deposits

    • Total reserves

      • Required reserves

      • Excess reserves


Open market operations
Open Market Operations

  • Fed purchases and sales of government securities

  • Fed purchases

    • Increase excess reserves

    • Increase new loans

    • Increase money supply

  • Fed sales

    • Decrease excess reserves

    • Decrease loans

    • Decrease money supply


Open market repurchase agreements
Open Market Repurchase Agreements

  • Repurchase Agreement

    • Fed buys securities from a seller who agrees to repurchase them at a higher price on a certain date in the future. (Temporary increase in excess reserves.)

  • Reverse Repurchase Agreement

    • Fed sells securities and agrees torepurchase them at a higher price on a certain date in the future. (Temporary decrease in excess reserves.)


Discount rate
Discount Rate

  • Rate charged on loans from the Fed’s discount window.

  • Administratively set by Board of Governors

  • An increase in the discount rate discourages banks from borrowing from the Fed

  • A decrease in the discount rate encourages banks to borrow from the Fed


Different uses of money
Different Uses of Money

  • Unit of Account

    • Numeraire

  • Medium of Exchange

    • Currency and demand deposits

  • Store of Value

    • Time deposits


Monetary aggregates
Monetary Aggregates

  • Monetary Base: Currency in circulation

    • Currency and coins plus total reserves

  • M1 Money Supply

    • Currency plus demand deposits

  • M2 Money Supply

    • M1 plus short-term time deposits

  • M3 Money Supply

    • M2 plus long-term time deposits


Money multiplier
Money Multiplier

  • Process by which changes in bank reserves generate larger changes in the money supply.

  • Size of Multiplier Influenced by:

    • Reserve requirement ratio

    • Public’s demand for cash

    • Banks’ willingness to make loans

    • Level of interest Rates


The money supply process in an open economy
The Money Supply Process in an Open Economy

  • Foreign Exchange Market Intervention

    • The Fed’s purchase and sale of foreign currencies

    • Purchase of foreign currencies

      • Increases monetary base

      • Reduces value of the U.S. currency

    • Sale of foreign currencies

      • Decreases monetary base

      • Increases value of the U.S. currency


Central banks around the world
Central Banks Around the World

  • European Central Bank

  • Bank of England

  • Bank of Japan


European central bank ecb
European Central Bank (ECB)

  • Replaced central banks in the 11 countries participating in the European Economic Community

  • Structure of ECB is decentralized

  • Major Issues: Weakness of Euro

  • Major Aspects: Transparency

  • Policy objective: price stability


England bank of england
England: Bank of England

  • Primary Roles: Monetary Policy and Stability of Financial System

  • Bank of England Act (1998)

    • No longer under control of Exchequer

    • Management of Government debt

  • Policy objective: price stability

  • Independence

  • Transparency


Japan bank of japan
Japan: Bank of Japan

  • Ministry of Finance

  • Bank of Japan Law (1998)

    • Independence

    • Transparency

  • Policy objective: price stability

  • Policy Board

  • TanKan Report