Some observers claim that the large increase in

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Chapter 25 / Exercise 2
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Some observers claim that the large increase in excess reserves implied that many of the policies introduced by the Federal Reserve in response to the financial crisis were ineffective. Rather than promoting the flow of credit to firms and households, critics argued that the increase in excess reserves indicated that the money lent to banks and other FIs by the Federal Reserve in late 2008 and 2009 was simply sitting idle in banks' reserve accounts. Many asked why banks were choosing to hold so many reserves instead of lending them out, and some claimed that banks' lending of their excess reserves was crucial for resolving the credit crisis. In this case, the Fed's lending policy generated a large quantity of excess reserves without changing banks' incentives to lend to firms and households. Thus, the total level of reserves in the banking system is determined almost entirely by the actions of the central bank and is not necessarily affected by private banks' lending decisions. Currency Outside Banks. The second largest liability, in terms of percent of total liabilities and equity, of the Federal Reserve System is currency in circulation (37.7 percent of total liabilities and equity). At the top of each Federal Reserve note ($1 bill, $5 bill, $10 bill, etc.) is the seal of the Federal Reserve Bank that issued it. Federal Reserve notes are basically IOUs from the issuing Federal Reserve Bank to the bearer. In the United States, Federal Reserve notes are recognized as the principal medium of exchange and therefore function as money (see Chapter 1). Assets. The major assets on the Federal Reserve's balance sheet are Treasury and government agency (i.e., Fannie Mae, Freddie Mac) securities, Treasury currency, and gold and foreign exchange. While loans to domestic banks are quite a small portion of the Federal Reserve's assets, they play an important role in implementing monetary policy (see below). U.S. Government Agency Securities. In 2010, U.S. government agency securities were the largest asset account on the Fed's balance sheet (52.9 percent of total assets). However, in June 2008, this account was 0.0 percent of total assets. This account grew as the Fed took steps to improve credit market liquidity and support the mortgage and housing markets during the financial crisis by buying mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Under the MBS purchase program, the FOMC called for the purchase of up to $1.25 trillion of agency MBS. The purchase activity began on January 5, 2009, and continued through March 31, 2010. Thus, the Fed expanded its role as purchaser/guarantor of assets in the financial markets. DO YOU UNDERSTAND: 1. 1. What the main functions of Federal Reserve Banks are? 2. 2. What the main responsibilities of the Federal Reserve Board are?
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