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88 Cards in this Set
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the interest rate on overnight loans of reserves from one bank to another |
Federal Funds Rate |
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The Fed's settings for the four tools of monetary policy determine... |
the Federal funds rate |
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What are the four tools of monetary policy? |
open market operations discount policy reserve requirements the interest paid on reserves |
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changes in non borrowed reserves |
open market operations |
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changes in borrowed reserves |
Federal Reserve Lending |
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Open Market Operations and Federal Reserve Lendings affect... |
the balance sheet of the Fed and the amount of reserves |
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The amount of reserves can be split up into two components: |
required reserves excess reserves |
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equal to the required reserve ratio times the amount of deposits on which reserves are required |
required reserves |
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the additional reserves banks choose to hold |
excess reserves |
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Excess reserves are... |
insurance against deposit outflows |
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the interest rate that could have been earned on lending these reserves out minus the interest rate that is earned on these reserves
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opportunity cost of excess reserves |
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As the federal funds rate decreases, the opportunity cost... |
of holding excess reserves falls; the quantity of reserves demanded rises. |
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The supply of reserves can be broken up into two components:
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non borrowed reserves borrowed reserves |
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The amount of reserves that are supplied by the Fed's open market operations |
nonborrowed reserves |
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the amount of reserves borrowed from the Fed |
borrowed reserves |
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If the federal funds rate is below the discount rate... |
then banks will not borrow from the Fed |
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What is the primary cost of borrowing from the Fed? |
the interest rate charged by the Fed on those loans |
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As the federal funds rate begins to rise above the discount rate, banks... |
will want to keep borrowing more and more at the discount rate then lending out the proceeds in the federal funds market at the higher rate. |
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An open market purchase causes... |
the Federal funds rate to fall. |
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AN open market sale causes... |
the federal funds rate to rise. |
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If the supply curve initially intersects the demand curve on its flat section... |
open market operations have no effect on the Federal Funds rate. |
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The interest rate paid on reserves... |
sets a floor for the federal funds rate. |
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Most changes in the discount rate... |
have no effect on the federal funds rate |
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When the Fed raises reserve requirements... |
the federal funds rate rises |
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When the Fed decreases reserve requirements... |
the federal funds rate falls. |
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When the federal funds rate is at the interest rate paid on reserves... |
a rise in the interest rate on reserves raises the federal funds rate. |
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What are the three conventional monetary policy tools? |
open market operations discount lending reserve requirements |
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Which is the most important conventional monetary policy tool? |
open market operations |
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Open market purchases... |
expand reserves and the monetary base, thereby increasing the money supply and lowering short-ten interest rates. |
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Open market sales... |
shrink reserves and the monetary base, decreasing the money supply and raising short-term interest rates. |
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Open market operations fall into two categories: |
dynamic open market operations defensive open market operations |
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intended to change the level of reserves and the monetary base |
dynamic open market operations |
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are intended to offset movements in other factors that affect reserves and the monetary base such as changes in Treasury deposits with the Fed or changes in float |
defensive open market operations |
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The decision-making authority for open market operations is the... |
Federal Open Market Committee, which sets a target rate for the federal funds rate. |
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Open market operations are conducted electronically through a specific set of dealers in government securities, known as... |
primary dealers |
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Defensive open market operations are of two basic types: |
repurchase agreements matched sale-purchase transaction |
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the Fed purchases securities with an agreement that the seller will repurchase them in a short period of time, anywhere from one to fifteen days from the original date of purchase |
repurchase agreement |
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A repo is actually a temporary open market purchase and is an... |
especially desirable way of confuting a defensive open market purchase that will be reversed shortly. |
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the Fed sells securities and the buyer agrees to sell them back to the Fed in the near future |
matched sale-purchase transaction (reverse repo) |
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The facility at which banks can borrow reserves from the Federal Reserve |
discount window |
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The Fed's discount loans to banks are of three types |
primary credit secondary credit seasonal credit |
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the discount lending that plays the most important role in monetary policy |
primary credit |
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The Fed prefers that banks... |
borrow from each other in the federal funds market so that they continually monitor each other for credit risk. |
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given to banks that are in financial trouble and are experiencing severe liquidity problems |
secondary credit |
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The interest rate on secondary credit loans is set at... |
a higher, penalty rate to reflect the less-sound condition of these borrowers. |
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given to meet the needs of a limited number of small banks in vacation and agricultural areas that have a seasonal pattern of deposits |
seasonal credit |
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discounting is important in... |
preventing and coping with financial panics |
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to prevent bank failures from spinning out of control, the Fed was to provide reserves to banks when no one else would, thereby preventing bank and financial panics |
lender of last resort |
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the Fed must use the discount tool wisely when... |
attempting to thwart financial panics |
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Financial panics can severely damage the economy because... |
they interfere with the ability of financial intermediaries and markets to move funds to people with productive investment opportunities. |
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It is important to recognize that the FDIC's insurance funds amounts to... |
about 1% of the total amount of deposits held by the banks. |
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The 1.7 trillion of large denomination deposits in the banking system are not... |
guaranteed by the FDIC because they exceed the 250k limit. |
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If a bank expects that the Fed will provide it with discount loans if it gets in trouble, then it will... |
be willing to take on more risk, knowing that the Fed will come to the rescue if necessary. |
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When the Fed considers using the discount weapon to prevent a panic, it needs to consider... |
the trade-off between the moral hazard cost of its role as lender of last resort and the benefit of preventing the financial panic. |
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A rise in reserve requirements reduces the amount of deposits that can... |
be supported by a given level of the monetary base and leads to a contraction of the money supply. |
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A decline in reserve requirements leads to... |
an expansion of the money supply and a fall in the federal funds rate. |
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All depository institutions are subject to... |
the same reserve requirements |
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The Fed to date generally has... |
set the interest rate on reserves below the federal funds target. |
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Open market operations constitute the most important conventional monetary policy tool because they have four basic advantages over the other tools: |
1. Open market operations occur at the initiative of the Fed, which has complete control over their volume. 2. Open market operations are flexible and precise; they can be used to the exact extent desired. 3. Open market operations are easily reserved. 4. Open market operations can be implemented quickly; they involve no administrative delays. |
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There are two situations in which the other tools have advantages over open market operations: |
1. when the Fed wants to raise interest rates after banks have accumulated large amounts of excess reserves. 2. when discount policy can be used by the Fed to perform its role as lender of last resort. |
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When the economy experiences a full-scale financial crisis like the one we recently experienced, conventional monetary policy tools cannot do the job, for two reasons: |
1. the financial system seizes up to such an extent that it becomes unable to allocate capital to productive issues. 2. The negative shock can lead to the zero-lower bound problem. |
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the central bank is unable to lower short-term interest rates further because they have hit a floor of zero |
zero-lower bound problem |
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Central banks need non-interest rate tools to stimulate the economy |
nonconventional monetary policy tools |
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These nonconventional monetary policy tools take three forms: |
liquidity provision asset purchases commitment to future monetary policy actions |
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Lowering the discount rate |
discount window expansion |
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to encourage additional borrowing the Fed set up a temporary ____ ______ ______, in which it made loans at a rate determined through competitive auctions. |
Term Auction Facility |
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the Fed broadened its provision of liquidity to the financial system well beyond its traditional lending to banking institutions |
new lending programs |
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During the crisis, the Fed started... |
two new large-scale asset purchase programs to lower interest rates for particular types of credit. |
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the Fed eventually purchased 1.25 trillion of mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac. |
Government Sponsored Entities program |
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large scale purchase program intended to lower long-term interest rates |
QE2 |
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combined elements of QE1 and QE2 |
QE3 |
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What is the goal of QE3? |
not to increase assets by a fixed dollar amount but instead was open-ended with the purchase plan set to continue if the outlook of the labor market didn't improve |
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expansion of the balance sheet, leads to a huge increase in the monetary base |
quantitative easing |
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It seems as though an expansion could be a powerful force in stimulating the economy in the near term and possibly producing inflation down the road. Reasons to be skeptical of this: (3) |
1. the huge expansion in the Fed's balance sheet and the monetary base did not result in a large increase in the money supply. 2. because the federal funds rate had already fallen to the zero lower bound 3. an increase in the monetary base does not mean that banks will increase lending |
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Altering the composition of the Fed's balance sheet can stimulate the economy in several ways. (2) |
1. When the Fed provides liquidity to a particular segment of the credit markets that has seized up, such liquidity can help unfreeze the market and thereby enable it to allocate capital to productive uses. 2. When the Fed purchases particular securities, it increases the demand for those securities and such an action can lower the interest rates on those securities relative to rates on other securities |
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By committing to the future policy action of keeping the federal funds rate at zero for an extended period, the Fed could... |
lower the market's expectations of future short-term interest rates, thereby causing the long-term interest rate to fall. |
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There are two types of commitments to future policy actions: |
conditional and unconditional |
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An unconditional commitment is stronger than a conditional commitment because... |
it does not suggest that the commitment will be abandoned and so is likely to have a larger effect on long-term interest rates. |
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Unconditional commitments have the disadvantage that, even if circumstances change in such a way that it would be better to abandon the commitment, the Fed may feel that.. |
it cannot go back on its word and therefore cannot abandon the commitment |
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Like the Federal Reserve, the European System of Central Banks signals... |
the stance of its monetary policy by setting a target financing rate, which in turn sets a target for the overnight cash rate. |
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the predominant form of open market operations and are similar to the Fed's repo transactions |
main refinancing operations |
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purchase or sale of eligible assets under repurchase or credit operations against eligible assets as collateral |
reverse transactions |
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In contrast to the Federal Reserve, which conducts open market operations in one location at the Federal Reserve Bank of New York, the European Central Bank... |
decentralizes its open market operations by conducting them through the individual national central banks. |
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a much smaller source of liquidity for the euro-area banking system and are similar to the Fed's outright purchases or sales of securities. |
longer-term refinancing operations |
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Lending to bank institutions takes place through a standing lending facility called the... |
marginal lending facility |
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Through marginal lending facilities... |
banks can borrow overnight loans from the national central banks at the marginal lending rate. |
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banks are paid a fixed interest rate that is 100 basis points below the target financing rate |
deposit facility |
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The European Central Bank imposes reserve requirements such that... |
all deposit taking institutions are required to hold 2% of the total amount of checking deposits and other short-term deposits in reserve accounts with national central banks. |
