FNCE 101 Lecture Notes - Lecture 14: Fractional-Reserve Banking, Financial System, Bank Charge
Audio 1
Audio recording started: 10:32 AM Monday, March 19, 2018
Weekly News Update
Inflation cooled down in Feb
a.
I.
Slide 3
Monetary Policy- process by which the fed reserve system controls the
money supply to promote econ growth
Not all of the feds power is held in washington
i.
When it was founded society was against big gov't
ii.
Had reps for each district
iii.
a.
Fed reserve system
Has board in washington; A public institution outside of the govt
i.
While fed reserve banks are privately owned by commercial banks
within their districts
ii.
Fed reserve system is a quasi public organization
Privately owned - manage money supply in their districts
1)
iii.
b.
Board in washington has 7 governors appointed by US president
12 members from each district, variations of industry, 4 appointed
by washington to represent the broader view of the nation
i.
c.
Chairman of the board has same voting power as other governors but
has a term of 4 yrs, the face of the system, link btwn fed and president
Has a lot of power
i.
Although chairman is nominated for f14 yrs, tradition is if u lose
title as chair of board you go out
ii.
d.
II.
Slide 4
Bookmark added at 08:30 in Audio 1
a.
Each fed reserve bank has a president
President is nominated by board of directors
Nomination can be rejected1)
i.
Pres serve 5 yr terms and may be reappointedii.
b.
12 dist reserve banks
Each bank is responsible for members in its district
Ie Fed reserve bank of NY is responsible for Citibank
Fed of NY is most impactful a)
Only district w seat of bank of international
settlements
Central bank of central banksi)
b)
1)
i.
c.
III.
Slide 5
Bookmark added at 11:17 in Audio 1a.
Congress est 2 objectives for monetary policy
Max employment, price stability
Keeping up w inflation keeping prices low and stable
2% inflation targeta)
1)
i.
b.
In most developped economies, price stability is the only mandate of
the central bank bc once you bring econ back to 2% u usually bring it
back to potential
c.
Dual mandate of the fed brings conflict btwn max employment and
stable prices when econ is faced w supply shock
Prices go up, employment goes down i.
When prices go up u wana increase fed fund rate but when it goes
down you need to bring output back to potential
ii.
Under DEMAND shock there is no conflict
W supply shock decisionc omes down to who is on the
board
1)
Ox -- max employment or dove - stbale price mandate2)
iii.
d.
IV.
Slide 6
Bookmark added at 13:40 in Audio 1a.
Left unemployment, right consumer inflation
Left - unemployment mande
Fed has done well since great recession, unemp rate is
below full potential output
1)
Right --fed hasn’t done so well since 2011, inflation has
been running below 2% target
2)
We would like to see inflation close to 2% unemployment
close to natural rate of full employment
We are currently belowa)
3)
i.
b.
V.
Slide 7
Bookmark added at 15:12 in Audio 1a.
Ppl who make decision FOMC
MP decisions are made by FOMC
Consists of 7 governors in washington plus 5 district bank
presidents on a roating basis
1)
Fed of NY is always one of them, cleveleand or chicago is
one of the other 3 remaining rotate around fed reserve
banks
2)
i.
b.
FOMC meets in washington 8 times a year
1 meeting w a statement (ending on a duesday)i.
2 day meetings end on a weds w a statement released and then a
press conference
ii.
c.
Most input comes from washington but each district also must come w
their own inputs
d.
VI.
Slide 9
Bookmark added at 20:11 in Audio 1a.
Research directors, advisorsb.
12 fed reserve banks in US so 12 are present at the meetingc.
Only 5 vote
All have an input (12) but among the 5 voting is NY cleveland or
chicago and the rest are distributed around the other banks
i.
d.
VII.
Slide 10
Bookmark added at 21:13 in Audio 1a.
U can hire legal consultant to find how a judge witill sway the caseb.
Fed does the same w FOMC
J powell is head of fed reservei.
This shows how heads are spread out between Doves and Hawksii.
c.
Financial market looks at composition of FOMC to figure out what is the
likely decision
d.
VIII.
Slide 11
Bookmark added at 22:12 in Audio 1a.
Fed reserve releases a statement at the conclusion of each of its policy
setting meetings
State of econi.
Policy decision on int rate targets ii.
Votes on policy iii.
Additionaly contains language discusing econ risks and where
FOMC thinks monetary policy may be headed
Most important
Since C and I usually come w borrowing costs over
time so it matter snot where rates are now but where
they are going
a)
Understanding wher emP is heading and whether int
rates will go up or down matters for setting long term
int rates and setting impact on borrowing
expenditures in consumption or investment
b)
1)
iv.
Statement language usually has the biggest impact on fin markets
Hints at where ST int rates are going
More relevant for household consumption and firms
infvestment decisions
a)
1)
v.
b.
IX.
Slide 12
Bookmark added at 24:06 in Audio 1a.
First p - state of econ, view of econb.
Second p -c.
Third p -decision d.
X.
Slide 13
Fed builds each statement (LISTEN TO RECORDING)
They’ll take out words so that there is continuity between
statements
Audio 2
i.
a.
Bookmark added at 25:38 in Audio 1b.
Statement -- didn’t c.
XI.
Slide 14
Audio recording started: 11:00 AM Monday, March 19, 2018a.
XII.
Slide 16
Audio 3
Audio recording started: 11:14 AM Monday, March 19, 2018a.
Fedb.
XIII.
Slide 16
Fed at the top
Distributes money to banks
Bnks thru loans gives $ to public for I, C< G1)
Transaction lead to further deposit to banks which turn into
loans and so on
2)
i.
a.
XIV.
Slide 17
Bookmark added at 01:50 in Audio 3a.
Central bank supplies monetary baseb.
Financial system multiplies the base by lednign and creating additional
monetary assets
c.
XV.
Slide 18
Bookmark added at 02:44 in Audio 3a.
Monetary Base - currency in circulation and vault cash held by banksb.
100% reserve banking
Bank resrves = bank depositi.
c.
Fractional reserve banking - bank reserves < bank deposits
Leads to money multiplier where money supply > money basei.
d.
Borrow from BOA
Boa loans to client 1 -- client one deposits to bank 1 they have to
kep 10 in reserves at fed and can lend extra 90
i.
As of now although 100 was injected in the fed 190 was created ii.
Then person who got 90 from fin transaction will go to bank 2iii.
Bank 2 keeps 10% that has to be held in fed reserve resault tleft w
81 they lend to customer 3
iv.
Keeps going until it creates 1000 dollar in crease in MS since
commercial banks don’t have to keep all of it in reserve
v.
BECAUSE ONLY FRACTION OF DEPOSIT HAS TO BE HELD IN BANKS
A INCRESE IN BASE
DIF BTWN BASE AND MONEY SUPPLY IS MONEY MULTIPLIER1)
vi.
e.
XVI.
Slide 19
Bookmark added at 05:33 in Audio 3a.
BASE - WHATS DETERMINED BY FEDb.
MONEY MULTIPLIER - RATIO BTWN MUNY ULTIPLIER AND BASEc.
XVII.
SLIDE 20
Bookmark added at 05:58 in Audio 3a.
Money supply is a multiple of the baseb.
Fed controls the banks through how much they borrow and lend which
then determines the money multiplier
c.
Base is truly determined by the fed d.
XVIII.
Slide 21
Bookmark added at 06:45 in Audio 3a.
FFR is the rate at which comm bank lend and borrow to eachother to
meet reserve requirements
b.
To stimulate output and inflation fed lowers the target FFR
A decrease in FFR
Decreaes borrowing costs among comm banks1)
Also leads to decrease in borrowing costs charged by comm
banks to firms and households firms and hosueholds in vest
more increasing AD putting econ back on path of full
potential output and higher inf
2)
i.
To slow down econ and inf pressure the fed will raise FFR
everything worksi n opposite direction
ii.
c.
While the fed targets FFR (nom int rate) what really mattersfor investors
and households I the real int rate
As long as inf is low stable and predictable fed can also control
real int rate
i.
d.
XIX.
Slide 22
Bookmark added at 08:34 in Audio 3a.
Nom fed fund rate - real fed fund rateb.
XX.
Slide 23
During normal time fed uses 4 MP inst to control money supply and int
rates
OMO
Bookmark added at 09:07 in Audio 31)
i.
The reserve req ii.
Discount lending/window - rate theyre willing to lend money over
night to ab ank so they can meet req
iii.
Int rate paid on reserve- rate on which fed pas resreve held by
comm bank at the fed
iv.
a.
XXI.
Slide 24
OMO - most common mean of implementing MP
To increase MS fed purchases m bonds from banking system and
feeds additional money to econ thru loans
i.
a.
When FFR is higher than target fed increases MS by purchasing govt
bonds
Increase in MS will make money less scarce reducing price of
money which is FFR
i.
b.
If FFR is less than target set by FOMC fed will take money out of the
system making money more scarce driving up price of money which is
FFR
c.
FFR is targeted and not fully controlled by the fed
Don’t mess w the fed they always win and make FFR go back to
target
i.
d.
2 tyepes
Offensive OMO - ment to drive up or down FFRi.
Bookmark added at 12:00 in Audio 3ii.
Defensive OMO - meant to stablize the FFRiii.
e.
XXII.
Slide 25
Bookmark added at 12:37 in Audio 3a.
Fed Funds are overnight borrowing by banks to maintain their bank
reserve at the Fed. Banks keep resrve at the fed to meet their reserve
req and clar financial trasaction
Bnks w excess resreves lend to banks w cash needsi.
If bank cant borrow from FFM it turns to fed and uses discount
window
ii.
b.
FFR is an equilibrium price not directly fixed by the fed but bounded
above by the discount rate id and below the int rate on reserves ior
c.
The fed changes the MS to match the targeted FR set by the FOMCd.
XXIII.
Slide 26
Bookmark added at 13:52 in Audio 3a.
Fed sets monetary base in econ -- the amt of cash the banking sector
has
b.
That amt of cash is non borrow - the fed can play w it by buying or
selling govt bonds
c.
The monetary base is fixd by the fed
If comm bank cant find the cash then they come to the fed
borriwng at discount rate
Rate is upper bound of FFR - rate at which fed supplies any
amt necessary to meet reserve req and clear market
transaction
1)
Demand side -- when supply is high banks have as little
resrve as possible lend out as little as possible
2)
When reserves are low, the fed would rather have security
of keepin git w the fed than lending it out
3)
At extreme cash is w the fed and u can earn int rate on
resrve
4)
FFR determined by supply of cash and demand of cash in
cecon
5)
Bounded by __________6)
i.
d.
Allude to slide 43e.
XXIV.
Slide 27
Bookmark added at 18:50 in Audio 3a.
If fed wants to increase the base fed borrowsb.
Increase in money on reserves drives down FFR c.
This happens unless u r at the floor (graph on right) d.
XXV.
Slide 28
Bookmark added at 19:37 in Audio 3a.
Fed can also change reserve reqb.
Inc in reserve req increases quantity of resrve demandedc.
Fed can also decrease the discount window which can be non binding or
binding or increase the floor which can be binding - no effect on FFR or
can be binding in which they move up the ffr by amt of the change in int
rate
d.
XXVI.
Slide 31
Bookmark added at 20:34 in Audio 3a.
FFR is bounded by the tdiscount rate and the int rate on reserve
(below) -- price they pay for resrves to be held at the fed
b.
Before 2008 there was no flloor (graph) c.
Since 08 we have a range for the fund rate bounded below by int rate
on resrve and above by discount rate
d.
Slide 32
FFR can only move w (_____) i.
e.
XXVII.
Monetary Policy an example (slide 33)
Bookmark added at 21:44 in Audio 3a.
Increase in FFR will lead to increase in borrowing costs across
econ which will decrease C I AD and inflation
i.
Inc in FFR (rate bank charge each other for short term loans)
increases other short term rates paid by firsm and households
ii.
Increase in FFR also have knock on effects on LT rates iii.
b.
c.
OMO
If u want to increase int rate u need to sell govt bonds
By selling them u bring in cash making cash more
scarce drives down price of cash drives down FFR
a)
1)
i.
Resrve requirements
If u want to inc int rate u inc reserve req increaseing
deamnd for reserve
1)
ii.
Discount rates
Increase (the ceiling)1)
iii.
Int rate on reserves
Increase both the floor and the ceiling1)
iv.
d.
XXVIII.
Lecture 14 -MONETARY POLICY
Monday, March 19, 2018
10:32 AM
Audio 1
Audio recording started: 10:32 AM Monday, March 19, 2018
Weekly News Update
Inflation cooled down in Feb a.
I.
Slide 3
Monetary Policy- process by which the fed reserve system controls the
money supply to promote econ growth
Not all of the feds power is held in washingtoni.
When it was founded society was against big gov'tii.
Had reps for each districtiii.
a.
Fed reserve system
Has board in washington; A public institution outside of the govti.
While fed reserve banks are privately owned by commercial banks
within their districts
ii.
Fed reserve system is a quasi public organization
Privately owned - manage money supply in their districts1)
iii.
b.
Board in washington has 7 governors appointed by US president
12 members from each district, variations of industry, 4 appointed
by washington to represent the broader view of the nation
i.
c.
Chairman of the board has same voting power as other governors but
has a term of 4 yrs, the face of the system, link btwn fed and president
Has a lot of power i.
Although chairman is nominated for f14 yrs, tradition is if u lose
title as chair of board you go out
ii.
d.
II.
Slide 4
Bookmark added at 08:30 in Audio 1
a.
Each fed reserve bank has a president
President is nominated by board of directors
Nomination can be rejected
1)
i.
Pres serve 5 yr terms and may be reappointed
ii.
b.
12 dist reserve banks
Each bank is responsible for members in its district
Ie Fed reserve bank of NY is responsible for Citibank
Fed of NY is most impactful
a)
Only district w seat of bank of international
settlements
Central bank of central banks
i)
b)
1)
i.
c.
III.
Slide 5
Bookmark added at 11:17 in Audio 1
a.
Congress est 2 objectives for monetary policy
Max employment, price stability
Keeping up w inflation keeping prices low and stable
2% inflation target
a)
1)
i.
b.
In most developped economies, price stability is the only mandate of
the central bank bc once you bring econ back to 2% u usually bring it
back to potential
c.
Dual mandate of the fed brings conflict btwn max employment and
stable prices when econ is faced w supply shock
Prices go up, employment goes down
i.
When prices go up u wana increase fed fund rate but when it goes
down you need to bring output back to potential
ii.
Under DEMAND shock there is no conflict
W supply shock decisionc omes down to who is on the
board
1)
Ox -- max employment or dove - stbale price mandate
2)
iii.
d.
IV.
Slide 6
Bookmark added at 13:40 in Audio 1
a.
Left unemployment, right consumer inflation
Left - unemployment mande
Fed has done well since great recession, unemp rate is
below full potential output
1)
Right --fed hasn’t done so well since 2011, inflation has
been running below 2% target
2)
We would like to see inflation close to 2% unemployment
close to natural rate of full employment
We are currently belowa)
3)
i.
b.
V.
Slide 7
Bookmark added at 15:12 in Audio 1a.
Ppl who make decision FOMC
MP decisions are made by FOMC
Consists of 7 governors in washington plus 5 district bank
presidents on a roating basis
1)
Fed of NY is always one of them, cleveleand or chicago is
one of the other 3 remaining rotate around fed reserve
banks
2)
i.
b.
FOMC meets in washington 8 times a year
1 meeting w a statement (ending on a duesday)i.
2 day meetings end on a weds w a statement released and then a
press conference
ii.
c.
Most input comes from washington but each district also must come w
their own inputs
d.
VI.
Slide 9
Bookmark added at 20:11 in Audio 1a.
Research directors, advisorsb.
12 fed reserve banks in US so 12 are present at the meetingc.
Only 5 vote
All have an input (12) but among the 5 voting is NY cleveland or
chicago and the rest are distributed around the other banks
i.
d.
VII.
Slide 10
Bookmark added at 21:13 in Audio 1a.
U can hire legal consultant to find how a judge witill sway the caseb.
Fed does the same w FOMC
J powell is head of fed reservei.
This shows how heads are spread out between Doves and Hawksii.
c.
Financial market looks at composition of FOMC to figure out what is the
likely decision
d.
VIII.
Slide 11
Bookmark added at 22:12 in Audio 1a.
Fed reserve releases a statement at the conclusion of each of its policy
setting meetings
State of econi.
Policy decision on int rate targets ii.
Votes on policy iii.
Additionaly contains language discusing econ risks and where
FOMC thinks monetary policy may be headed
Most important
Since C and I usually come w borrowing costs over
time so it matter snot where rates are now but where
they are going
a)
Understanding wher emP is heading and whether int
rates will go up or down matters for setting long term
int rates and setting impact on borrowing
expenditures in consumption or investment
b)
1)
iv.
Statement language usually has the biggest impact on fin markets
Hints at where ST int rates are going
More relevant for household consumption and firms
infvestment decisions
a)
1)
v.
b.
IX.
Slide 12
Bookmark added at 24:06 in Audio 1a.
First p - state of econ, view of econb.
Second p -c.
Third p -decision d.
X.
Slide 13
Fed builds each statement (LISTEN TO RECORDING)
They’ll take out words so that there is continuity between
statements
Audio 2
i.
a.
Bookmark added at 25:38 in Audio 1b.
Statement -- didn’t c.
XI.
Slide 14
Audio recording started: 11:00 AM Monday, March 19, 2018a.
XII.
Slide 16
Audio 3
Audio recording started: 11:14 AM Monday, March 19, 2018a.
Fedb.
XIII.
Slide 16
Fed at the top
Distributes money to banks
Bnks thru loans gives $ to public for I, C< G1)
Transaction lead to further deposit to banks which turn into
loans and so on
2)
i.
a.
XIV.
Slide 17
Bookmark added at 01:50 in Audio 3a.
Central bank supplies monetary baseb.
Financial system multiplies the base by lednign and creating additional
monetary assets
c.
XV.
Slide 18
Bookmark added at 02:44 in Audio 3a.
Monetary Base - currency in circulation and vault cash held by banksb.
100% reserve banking
Bank resrves = bank depositi.
c.
Fractional reserve banking - bank reserves < bank deposits
Leads to money multiplier where money supply > money basei.
d.
Borrow from BOA
Boa loans to client 1 -- client one deposits to bank 1 they have to
kep 10 in reserves at fed and can lend extra 90
i.
As of now although 100 was injected in the fed 190 was created ii.
Then person who got 90 from fin transaction will go to bank 2iii.
Bank 2 keeps 10% that has to be held in fed reserve resault tleft w
81 they lend to customer 3
iv.
Keeps going until it creates 1000 dollar in crease in MS since
commercial banks don’t have to keep all of it in reserve
v.
BECAUSE ONLY FRACTION OF DEPOSIT HAS TO BE HELD IN BANKS
A INCRESE IN BASE
DIF BTWN BASE AND MONEY SUPPLY IS MONEY MULTIPLIER1)
vi.
e.
XVI.
Slide 19
Bookmark added at 05:33 in Audio 3a.
BASE - WHATS DETERMINED BY FEDb.
MONEY MULTIPLIER - RATIO BTWN MUNY ULTIPLIER AND BASEc.
XVII.
SLIDE 20
Bookmark added at 05:58 in Audio 3a.
Money supply is a multiple of the baseb.
Fed controls the banks through how much they borrow and lend which
then determines the money multiplier
c.
Base is truly determined by the fed d.
XVIII.
Slide 21
Bookmark added at 06:45 in Audio 3a.
FFR is the rate at which comm bank lend and borrow to eachother to
meet reserve requirements
b.
To stimulate output and inflation fed lowers the target FFR
A decrease in FFR
Decreaes borrowing costs among comm banks1)
Also leads to decrease in borrowing costs charged by comm
banks to firms and households firms and hosueholds in vest
more increasing AD putting econ back on path of full
potential output and higher inf
2)
i.
To slow down econ and inf pressure the fed will raise FFR
everything worksi n opposite direction
ii.
c.
While the fed targets FFR (nom int rate) what really mattersfor investors
and households I the real int rate
As long as inf is low stable and predictable fed can also control
real int rate
i.
d.
XIX.
Slide 22
Bookmark added at 08:34 in Audio 3a.
Nom fed fund rate - real fed fund rateb.
XX.
Slide 23
During normal time fed uses 4 MP inst to control money supply and int
rates
OMO
Bookmark added at 09:07 in Audio 31)
i.
The reserve req ii.
Discount lending/window - rate theyre willing to lend money over
night to ab ank so they can meet req
iii.
Int rate paid on reserve- rate on which fed pas resreve held by
comm bank at the fed
iv.
a.
XXI.
Slide 24
OMO - most common mean of implementing MP
To increase MS fed purchases m bonds from banking system and
feeds additional money to econ thru loans
i.
a.
When FFR is higher than target fed increases MS by purchasing govt
bonds
Increase in MS will make money less scarce reducing price of
money which is FFR
i.
b.
If FFR is less than target set by FOMC fed will take money out of the
system making money more scarce driving up price of money which is
FFR
c.
FFR is targeted and not fully controlled by the fed
Don’t mess w the fed they always win and make FFR go back to
target
i.
d.
2 tyepes
Offensive OMO - ment to drive up or down FFRi.
Bookmark added at 12:00 in Audio 3ii.
Defensive OMO - meant to stablize the FFRiii.
e.
XXII.
Slide 25
Bookmark added at 12:37 in Audio 3a.
Fed Funds are overnight borrowing by banks to maintain their bank
reserve at the Fed. Banks keep resrve at the fed to meet their reserve
req and clar financial trasaction
Bnks w excess resreves lend to banks w cash needsi.
If bank cant borrow from FFM it turns to fed and uses discount
window
ii.
b.
FFR is an equilibrium price not directly fixed by the fed but bounded
above by the discount rate id and below the int rate on reserves ior
c.
The fed changes the MS to match the targeted FR set by the FOMCd.
XXIII.
Slide 26
Bookmark added at 13:52 in Audio 3a.
Fed sets monetary base in econ -- the amt of cash the banking sector
has
b.
That amt of cash is non borrow - the fed can play w it by buying or
selling govt bonds
c.
The monetary base is fixd by the fed
If comm bank cant find the cash then they come to the fed
borriwng at discount rate
Rate is upper bound of FFR - rate at which fed supplies any
amt necessary to meet reserve req and clear market
transaction
1)
Demand side -- when supply is high banks have as little
resrve as possible lend out as little as possible
2)
When reserves are low, the fed would rather have security
of keepin git w the fed than lending it out
3)
At extreme cash is w the fed and u can earn int rate on
resrve
4)
FFR determined by supply of cash and demand of cash in
cecon
5)
Bounded by __________6)
i.
d.
Allude to slide 43e.
XXIV.
Slide 27
Bookmark added at 18:50 in Audio 3a.
If fed wants to increase the base fed borrowsb.
Increase in money on reserves drives down FFR c.
This happens unless u r at the floor (graph on right) d.
XXV.
Slide 28
Bookmark added at 19:37 in Audio 3a.
Fed can also change reserve reqb.
Inc in reserve req increases quantity of resrve demandedc.
Fed can also decrease the discount window which can be non binding or
binding or increase the floor which can be binding - no effect on FFR or
can be binding in which they move up the ffr by amt of the change in int
rate
d.
XXVI.
Slide 31
Bookmark added at 20:34 in Audio 3a.
FFR is bounded by the tdiscount rate and the int rate on reserve
(below) -- price they pay for resrves to be held at the fed
b.
Before 2008 there was no flloor (graph) c.
Since 08 we have a range for the fund rate bounded below by int rate
on resrve and above by discount rate
d.
Slide 32
FFR can only move w (_____) i.
e.
XXVII.
Monetary Policy an example (slide 33)
Bookmark added at 21:44 in Audio 3a.
Increase in FFR will lead to increase in borrowing costs across
econ which will decrease C I AD and inflation
i.
Inc in FFR (rate bank charge each other for short term loans)
increases other short term rates paid by firsm and households
ii.
Increase in FFR also have knock on effects on LT rates iii.
b.
c.
OMO
If u want to increase int rate u need to sell govt bonds
By selling them u bring in cash making cash more
scarce drives down price of cash drives down FFR
a)
1)
i.
Resrve requirements
If u want to inc int rate u inc reserve req increaseing
deamnd for reserve
1)
ii.
Discount rates
Increase (the ceiling)1)
iii.
Int rate on reserves
Increase both the floor and the ceiling1)
iv.
d.
XXVIII.
Lecture 14 -MONETARY POLICY
Monday, March 19, 2018 10:32 AM
Audio 1
Audio recording started: 10:32 AM Monday, March 19, 2018
Weekly News Update
Inflation cooled down in Feb a.
I.
Slide 3
Monetary Policy- process by which the fed reserve system controls the
money supply to promote econ growth
Not all of the feds power is held in washingtoni.
When it was founded society was against big gov'tii.
Had reps for each districtiii.
a.
Fed reserve system
Has board in washington; A public institution outside of the govti.
While fed reserve banks are privately owned by commercial banks
within their districts
ii.
Fed reserve system is a quasi public organization
Privately owned - manage money supply in their districts1)
iii.
b.
Board in washington has 7 governors appointed by US president
12 members from each district, variations of industry, 4 appointed
by washington to represent the broader view of the nation
i.
c.
Chairman of the board has same voting power as other governors but
has a term of 4 yrs, the face of the system, link btwn fed and president
Has a lot of power i.
Although chairman is nominated for f14 yrs, tradition is if u lose
title as chair of board you go out
ii.
d.
II.
Slide 4
Bookmark added at 08:30 in Audio 1a.
Each fed reserve bank has a president
President is nominated by board of directors
Nomination can be rejected1)
i.
Pres serve 5 yr terms and may be reappointedii.
b.
12 dist reserve banks
Each bank is responsible for members in its district
Ie Fed reserve bank of NY is responsible for Citibank
Fed of NY is most impactful a)
Only district w seat of bank of international
settlements
Central bank of central banksi)
b)
1)
i.
c.
III.
Slide 5
Bookmark added at 11:17 in Audio 1a.
Congress est 2 objectives for monetary policy
Max employment, price stability
Keeping up w inflation keeping prices low and stable
2% inflation targeta)
1)
i.
b.
In most developped economies, price stability is the only mandate of
the central bank bc once you bring econ back to 2% u usually bring it
back to potential
c.
Dual mandate of the fed brings conflict btwn max employment and
stable prices when econ is faced w supply shock
Prices go up, employment goes down i.
When prices go up u wana increase fed fund rate but when it goes
down you need to bring output back to potential
ii.
Under DEMAND shock there is no conflict
W supply shock decisionc omes down to who is on the
board
1)
Ox -- max employment or dove - stbale price mandate2)
iii.
d.
IV.
Slide 6
Bookmark added at 13:40 in Audio 1a.
Left unemployment, right consumer inflation
Left - unemployment mande
Fed has done well since great recession, unemp rate is
below full potential output
1)
Right --fed hasn’t done so well since 2011, inflation has
been running below 2% target
2)
We would like to see inflation close to 2% unemployment
close to natural rate of full employment
We are currently below
a)
3)
i.
b.
V.
Slide 7
Bookmark added at 15:12 in Audio 1
a.
Ppl who make decision FOMC
MP decisions are made by FOMC
Consists of 7 governors in washington plus 5 district bank
presidents on a roating basis
1)
Fed of NY is always one of them, cleveleand or chicago is
one of the other 3 remaining rotate around fed reserve
banks
2)
i.
b.
FOMC meets in washington 8 times a year
1 meeting w a statement (ending on a duesday)
i.
2 day meetings end on a weds w a statement released and then a
press conference
ii.
c.
Most input comes from washington but each district also must come w
their own inputs
d.
VI.
Slide 9
Bookmark added at 20:11 in Audio 1
a.
Research directors, advisors
b.
12 fed reserve banks in US so 12 are present at the meeting
c.
Only 5 vote
All have an input (12) but among the 5 voting is NY cleveland or
chicago and the rest are distributed around the other banks
i.
d.
VII.
Slide 10
Bookmark added at 21:13 in Audio 1
a.
U can hire legal consultant to find how a judge witill sway the case
b.
Fed does the same w FOMC
J powell is head of fed reserve
i.
This shows how heads are spread out between Doves and Hawks
ii.
c.
Financial market looks at composition of FOMC to figure out what is the
likely decision
d.
VIII.
Slide 11
Bookmark added at 22:12 in Audio 1
a.
Fed reserve releases a statement at the conclusion of each of its policy
setting meetings
State of econ
i.
Policy decision on int rate targets
ii.
Votes on policy
iii.
Additionaly contains language discusing econ risks and where
FOMC thinks monetary policy may be headed
Most important
Since C and I usually come w borrowing costs over
time so it matter snot where rates are now but where
they are going
a)
Understanding wher emP is heading and whether int
rates will go up or down matters for setting long term
int rates and setting impact on borrowing
expenditures in consumption or investment
b)
1)
iv.
Statement language usually has the biggest impact on fin markets
Hints at where ST int rates are going
More relevant for household consumption and firms
infvestment decisions
a)
1)
v.
b.
IX.
Slide 12
Bookmark added at 24:06 in Audio 1a.
First p - state of econ, view of econb.
Second p -c.
Third p -decision d.
X.
Slide 13
Fed builds each statement (LISTEN TO RECORDING)
They’ll take out words so that there is continuity between
statements
Audio 2
i.
a.
Bookmark added at 25:38 in Audio 1b.
Statement -- didn’t c.
XI.
Slide 14
Audio recording started: 11:00 AM Monday, March 19, 2018a.
XII.
Slide 16
Audio 3
Audio recording started: 11:14 AM Monday, March 19, 2018a.
Fedb.
XIII.
Slide 16
Fed at the top
Distributes money to banks
Bnks thru loans gives $ to public for I, C< G1)
Transaction lead to further deposit to banks which turn into
loans and so on
2)
i.
a.
XIV.
Slide 17
Bookmark added at 01:50 in Audio 3a.
Central bank supplies monetary baseb.
Financial system multiplies the base by lednign and creating additional
monetary assets
c.
XV.
Slide 18
Bookmark added at 02:44 in Audio 3a.
Monetary Base - currency in circulation and vault cash held by banksb.
100% reserve banking
Bank resrves = bank depositi.
c.
Fractional reserve banking - bank reserves < bank deposits
Leads to money multiplier where money supply > money basei.
d.
Borrow from BOA
Boa loans to client 1 -- client one deposits to bank 1 they have to
kep 10 in reserves at fed and can lend extra 90
i.
As of now although 100 was injected in the fed 190 was created ii.
Then person who got 90 from fin transaction will go to bank 2iii.
Bank 2 keeps 10% that has to be held in fed reserve resault tleft w
81 they lend to customer 3
iv.
Keeps going until it creates 1000 dollar in crease in MS since
commercial banks don’t have to keep all of it in reserve
v.
BECAUSE ONLY FRACTION OF DEPOSIT HAS TO BE HELD IN BANKS
A INCRESE IN BASE
DIF BTWN BASE AND MONEY SUPPLY IS MONEY MULTIPLIER1)
vi.
e.
XVI.
Slide 19
Bookmark added at 05:33 in Audio 3a.
BASE - WHATS DETERMINED BY FEDb.
MONEY MULTIPLIER - RATIO BTWN MUNY ULTIPLIER AND BASEc.
XVII.
SLIDE 20
Bookmark added at 05:58 in Audio 3a.
Money supply is a multiple of the baseb.
Fed controls the banks through how much they borrow and lend which
then determines the money multiplier
c.
Base is truly determined by the fed d.
XVIII.
Slide 21
Bookmark added at 06:45 in Audio 3a.
FFR is the rate at which comm bank lend and borrow to eachother to
meet reserve requirements
b.
To stimulate output and inflation fed lowers the target FFR
A decrease in FFR
Decreaes borrowing costs among comm banks1)
Also leads to decrease in borrowing costs charged by comm
banks to firms and households firms and hosueholds in vest
more increasing AD putting econ back on path of full
potential output and higher inf
2)
i.
To slow down econ and inf pressure the fed will raise FFR
everything worksi n opposite direction
ii.
c.
While the fed targets FFR (nom int rate) what really mattersfor investors
and households I the real int rate
As long as inf is low stable and predictable fed can also control
real int rate
i.
d.
XIX.
Slide 22
Bookmark added at 08:34 in Audio 3a.
Nom fed fund rate - real fed fund rateb.
XX.
Slide 23
During normal time fed uses 4 MP inst to control money supply and int
rates
OMO
Bookmark added at 09:07 in Audio 31)
i.
The reserve req ii.
Discount lending/window - rate theyre willing to lend money over
night to ab ank so they can meet req
iii.
Int rate paid on reserve- rate on which fed pas resreve held by
comm bank at the fed
iv.
a.
XXI.
Slide 24
OMO - most common mean of implementing MP
To increase MS fed purchases m bonds from banking system and
feeds additional money to econ thru loans
i.
a.
When FFR is higher than target fed increases MS by purchasing govt
bonds
Increase in MS will make money less scarce reducing price of
money which is FFR
i.
b.
If FFR is less than target set by FOMC fed will take money out of the
system making money more scarce driving up price of money which is
FFR
c.
FFR is targeted and not fully controlled by the fed
Don’t mess w the fed they always win and make FFR go back to
target
i.
d.
2 tyepes
Offensive OMO - ment to drive up or down FFRi.
Bookmark added at 12:00 in Audio 3ii.
Defensive OMO - meant to stablize the FFRiii.
e.
XXII.
Slide 25
Bookmark added at 12:37 in Audio 3a.
Fed Funds are overnight borrowing by banks to maintain their bank
reserve at the Fed. Banks keep resrve at the fed to meet their reserve
req and clar financial trasaction
Bnks w excess resreves lend to banks w cash needsi.
If bank cant borrow from FFM it turns to fed and uses discount
window
ii.
b.
FFR is an equilibrium price not directly fixed by the fed but bounded
above by the discount rate id and below the int rate on reserves ior
c.
The fed changes the MS to match the targeted FR set by the FOMCd.
XXIII.
Slide 26
Bookmark added at 13:52 in Audio 3a.
Fed sets monetary base in econ -- the amt of cash the banking sector
has
b.
That amt of cash is non borrow - the fed can play w it by buying or
selling govt bonds
c.
The monetary base is fixd by the fed
If comm bank cant find the cash then they come to the fed
borriwng at discount rate
Rate is upper bound of FFR - rate at which fed supplies any
amt necessary to meet reserve req and clear market
transaction
1)
Demand side -- when supply is high banks have as little
resrve as possible lend out as little as possible
2)
When reserves are low, the fed would rather have security
of keepin git w the fed than lending it out
3)
At extreme cash is w the fed and u can earn int rate on
resrve
4)
FFR determined by supply of cash and demand of cash in
cecon
5)
Bounded by __________6)
i.
d.
Allude to slide 43e.
XXIV.
Slide 27
Bookmark added at 18:50 in Audio 3a.
If fed wants to increase the base fed borrowsb.
Increase in money on reserves drives down FFR c.
This happens unless u r at the floor (graph on right) d.
XXV.
Slide 28
Bookmark added at 19:37 in Audio 3a.
Fed can also change reserve reqb.
Inc in reserve req increases quantity of resrve demandedc.
Fed can also decrease the discount window which can be non binding or
binding or increase the floor which can be binding - no effect on FFR or
can be binding in which they move up the ffr by amt of the change in int
rate
d.
XXVI.
Slide 31
Bookmark added at 20:34 in Audio 3a.
FFR is bounded by the tdiscount rate and the int rate on reserve
(below) -- price they pay for resrves to be held at the fed
b.
Before 2008 there was no flloor (graph) c.
Since 08 we have a range for the fund rate bounded below by int rate
on resrve and above by discount rate
d.
Slide 32
FFR can only move w (_____) i.
e.
XXVII.
Monetary Policy an example (slide 33)
Bookmark added at 21:44 in Audio 3a.
Increase in FFR will lead to increase in borrowing costs across
econ which will decrease C I AD and inflation
i.
Inc in FFR (rate bank charge each other for short term loans)
increases other short term rates paid by firsm and households
ii.
Increase in FFR also have knock on effects on LT rates iii.
b.
c.
OMO
If u want to increase int rate u need to sell govt bonds
By selling them u bring in cash making cash more
scarce drives down price of cash drives down FFR
a)
1)
i.
Resrve requirements
If u want to inc int rate u inc reserve req increaseing
deamnd for reserve
1)
ii.
Discount rates
Increase (the ceiling)1)
iii.
Int rate on reserves
Increase both the floor and the ceiling1)
iv.
d.
XXVIII.
Lecture 14 -MONETARY POLICY
Monday, March 19, 2018 10:32 AM
Document Summary
Audio recording started: 10:32 am monday, march 19, 2018. Monetary policy- process by which the fed reserve system controls the money supply to promote econ growth i. ii. iii. Not all of the feds power is held in washington. When it was founded society was against big gov"t. Has board in washington; a public institution outside of the govt. While fed reserve banks are privately owned by commercial banks within their districts. Fed reserve system is a quasi public organization. Privately owned - manage money supply in their districts c. Board in washington has 7 governors appointed by us president i. 12 members from each district, variations of industry, 4 appointed by washington to represent the broader view of the nation d. Chairman of the board has same voting power as other governors but has a term of 4 yrs, the face of the system, link btwn fed and president i. ii.