im18 - Chapter 18 Changes in the Monetary Base Overview One...

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Chapter 18 Changes in the Monetary Base Overview One reason that students may have difficulty understanding how the Fed carries out monetary policy is that they have had no exposure to the mechanics of managing the monetary base. This chapter lays out the details of monetary base management. A discussion of the Fed’s balance sheet provides the framework within which the discussion proceeds. Movements in the base are shown to be linked to movements in the Fed’s assets and liabilities. The chapter concludes with a discussion of the ways in which a federal budget deficit may affect the base. The important concept of the government budget constraint is introduced in this discussion. The federal budget deficit must equal the sum of the change in Treasury securities held by banks and the nonbank public and the increase in the monetary base. Here is another point in the course to emphasize that, while the Treasury is in charge of paying the federal government’s bills, it isn’t in charge of issuing currency. When the Fed chooses to purchase Treasury securities to finance budget deficits, it is monetizing the debt. However, the Fed is not obliged to help finance budget deficits, so there is no direct relationship between government deficits and the monetary base. Question 7 in the additional questions provides a basis for a discussion of this point. Outline I. Balance Sheet of the Federal Reserve System A) Although changes in the Fed’s securities holdings and discount loans are the major sources of variation in the monetary base, other sources of variation can be identified from the Fed’s balance sheet. B) The Fed acquires securities in open market operations and holds other assets as a result of its role as a bankers’ bank. 1. Securities in the Fed’s portfolio consist mostly of U.S. Treasury securities, with smaller amounts of U.S. government agency securities and bankers’ acceptances. 2. Discount Loans are made by the Fed to banks, generally to assist them in overcoming short- term liquidity problems. 3. Items in the Process of Collection are holdings from the Fed’s check-clearing role in the payments system. 4. Other Federal Reserve Assets include the Fed’s foreign-exchange reserves, as well as buildings, equipment, and other physical goods owned by the Fed. 5. The Gold and SDR Certificate Accounts consist of certificates issued by the U.S. Treasury to the Fed when the Treasury acquires gold or special drawing rights (SDRs), which are issued by the International Monetary Fund. 6. Treasury currency outstanding consists of U.S. Treasury currency held by the Fed.
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102 Hubbard • Money, the Financial System, and the Economy, Sixth Edition C) The Fed’s principal liability is currency outstanding, but it has other liabilities as well. 1. Currency Outstanding is currency issued by the Fed in the form of Federal Reserve Notes.
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im18 - Chapter 18 Changes in the Monetary Base Overview One...

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