16--Monetary Lesson Policy and The Economy/Tools of the Fed
M&B -- chapter 16
Goals of Monetary Policy--The Federal Reserve Act Maximum Sustainable Growth & Employment Price Stability Moderate Long Term Interest Rates (these
days presumed to be a function of stable prices)
What Is Maximum Sustainable Growth?
What Do We Mean by Maximum Sustainable Employment?
History of Unemployment Rate vs Common Notions of NAIRU
Civilian Unemployment Rate vs Common Notions of Upper and Lower Bounds on NAIRU
11.50 10.50 9.50 8.50 7.50 6.50 5.50 4.50 3.50 2.50
What Do We Mean By Price Stability?
Current Fed Debate: Inflation Rate or Price Level Target
Basic Tools of the Fed
Open Market Operations Reserve Requirements Discount Window Loans
New Tools in the Toolbox-- Crisis or Zero-Bound
Interest on Reserves Large Scale Asset Purchases or what some people are calling "Quantitative Easing" Purchases of Agency and Agency Related MBS Opening the Discount Window to Nonbanks using Section 13 (3) of the Federal Reserve Act
Open Market Operations are aimed at manipulating Fed's Balance Sheet to affect the level of Bank Reserve Balances
Federal Reserve (before Crisis related tools added)
assets Securities
Held Outright Repurchase Agreements
liabilties Bank Reserves Currency in Circulation Reverse Repurchase Agreements Treasury Deposits
Discount Window Loans Float Other Assets
Other Liabilities & Capital
Open Market Tools
To Add Reserves
Buy Securities Outright Engage in Temporary Repuchase Agreement (RP)
To Drain Reserves
Sell Securities Outright Engage in Reverse RP (RRP)
The Fed's Open Market Desk buys and sells securities through "Primary Government Securities Dealers"
BNP Paribas Securities Corp. Banc of America Securities LLC Barclays Capital Inc. Cantor Fitzgerald & Co. Citigroup Global Markets Inc. Credit Suisse Securities (USA) LLC Daiwa Capital Markets America Inc. Deutsche Bank Securities Inc. Goldman, Sachs & Co. HSBC Securities (USA) Inc. Jefferies & Company, Inc. J.P. Morgan Securities LLC Mizuho Securities USA Inc. Morgan Stanley & Co. Incorporated Nomura Securities International, Inc. RBC Capital Markets Corporation RBS Securities Inc. UBS Securities LLC.
Example: Fed Buys Securities From Merrill Lynch Increasing Bank Reserves
Fe de ra l Re se rve
asset s + $1 bln Securit ies liabilt ies + $1 bln Reserves - $1 bln Securit ies + $1 bln Deposit
M e rrill Lyn ch
asset s liabilt ies
Cit iba n k
asset s + $1 bln Reserves liabilt ies + $1 bln Merrill Deposit
Buying Securities Increases Bank Reserves and Drives the Fed Funds Rate of Lower
Types Open Market Operations
Dynamic---Aimed at fundamentally changing the funds rate target--Policy Decision Defensive--Aimed at offsetting changes in the autonomous reserve factors (those that add or drain reserves) with an intent of getting the funds rate to trade close to target
Defensive Operation--Assume demand curve shifts right reflecting an increase in excess reserve demand stemming from uncertainty. If the Fed did nothing funds rate would rise. As defensive operation Fed adds reserves and shifts supply curve to right, such that the funds rate is maintained at 3-1/2%
Demand for Reserves= Excess Demand + Required Reserves inclusive of Clearing Balances
Supply of Reserves = Balances with Fed + Vault Cash
Crisis Related Surges in Excess Reserves
Current Reserve Requirements: The Computation Period for RR is a 2-week period (Tuesday thru 2nd Monday), and begins 30 days ahead of the beginning of the Reserve Maintenance Period
Lagged Reserve Accounting:
Required Reserve Computation Period (yellow) Required Reserve maintenance Period (grey)
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Recent Fed Balance Sheet
Federal Reserve Balance Sheet
Weekly average ended December 19, 2007 ($blns) assets
$769.7 Outrights $55.8 RPs $819.6 Currency in Circulation $7.5 Treasury Deposits $4.6 Other Discount Advances $37.1 Reverse RPs (Foreign Official) $0.0 Reverse RPs (Dealers) -$0.4 Float $41.2 Other FR Assets
( includ ing SW A P d r awing s)
liabilties
$8.8 Reserve Balances
$50.0 All Other Liabilities & Capital
$870.9 Total Reserve Bank Credit $11.0 Gold stock $2.2 Special Drawing Rights $38.8 Treasury Currency Outstanding $923.0 Total Factors Suppl yi ng Reserves $923.0 Total Li abi l i ti es & Capi tal $914.2 Factors Absorbing Reserves
Currency in Circulation is largest single factor absorbing reserves (note recurring seasonal pattern)
Treasury Deposits held at the Fed drain reserves
(note recurring quarterly pattern associated with key tax payment dates)
The Fed's balance sheet includes a liability item entitled "Reverse RPs" with Foreign Official Institutions (Foreign Central Banks).
Float Adds Reserves...What is float? How might float be related to the weather?
Discount Window Borrowings