ECON-002 Lecture Notes - Lecture 17: Money Supply, Reserve Requirement, Federal Open Market Committee

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27 Mar 2017
March 16th, 2017
Introducing the Federal Reserve
Central Bank of the US
Hollywood Financial Crisis:
-when depositors go to banks and try to withdraw their entire life savings
-this creates general panic
-making bad loans, still have to pay back their depositors
-toxic assets (bad securities); were not worth what the bank thought they were worth
-excessive borrowing in order to alleviate the toxic asset and bad loan situation
Real World Financial Crisis:
-in China: rumor arose that the bank refused to give a depositor back their money; eventually there
was a “run on the bank”
-Cyprus also had a big problem after US recession (march 2013); Cyprus bank was holding bad
loans, also had to deal with Greek government debt. When Greece engineered its debt swap, all the
Greek government bonds that Cyprus banks had became toxic assets.
-Ukraine (2014): failing loans, risky government debt, plus too much borrowing to be paid back in
euros. The price of Hryvnia falls (the Ukranian currency), and that borrowing becomes much more
How does a central bank help/stop banking crises?
-once banks realize what trouble their in, they stop making loans
-Central bank is “a lender of last resort” for borrowing
-The bank uses the federal reserves to pay out the loans (increases reserves with funds borrowed
from central bank)
A Central Bank has 3 jobs:
1. avert financial crisis
-uses funds to increase the reserves
-is a “lender of last resort” for borrowing
2. serve as bank for Treasury, Commercial banks
3. devise macroeconomic policy
-Employment Act of 1946: mandate = maximize growth
-Humphrey-Hawkins 1978: mandate = stable inflation, full employment
-stable inflation, low unemployment
Structural details of the Fed:
Current Chair: Janet Yellen
Previous Chair: Ben Bernanke
Board of Governors
12 district banks — research on regional economic conditions
FOMC — Federal Open Market Committee
-group within the fed that makes monetary policy
-consists of the 7 governors and 5 of the 12 district bank presidents
-FOMC decides interest rates
Open-Market Operations
-the Fed controls the size of the Money Supply by conducting Open-Market Operations (OMO)
-An OMO is an exchange of commercial bank reserves for securities
-Open-Market Sale: Fed sells securities, reduces bank reserves
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