Class Notes for CH 4 Summary - book \"Financial Markets and Institutions\" PDF

Preview

Summary

Class Notes for CH 4: The Federal Reserve System, Monetary Policy, and Interest Rates ** where does the US bank fall in the ranking? (#7 JP Morgan). JP Morgan Chase and BoA are not even in the top 5 banks of the world. Ranked by total assets. Relbanks Outline -Inflation Example -Banking example, flo...

Description

Class Notes for CH 4: The Federal Reserve System, Monetary Policy, and Interest Rates ** where does the US bank fall in the ranking? (#7 JP Morgan). JP Morgan Chase and BoA are not even in the top 5 banks of the world. Ranked by total assets. Relbanks.com Outline -Inflation Example -Banking example, flow of funds through the economy -Functions of the Fed -“Structure of the Federal Reserve System” Member Banks Board of Governors Federal Open Market Committee -Balance Sheet of Federal Reserve System -“Monetary Policy Tools” -“The Federal Reserve, The Money Supply, and Interest Rates”

Learning Goals From Bernstein Book Understand how money travels through the economy Understand the role of banks in increasing the money supply

From Saunders-Cornett Book LG 4-1. Understand the major functions of the Federal Reserve System LG 4-2. Identify the structure of the Federal Reserve System LG 4-3. Identify the monetary policy tools used by the Federal Reserve LG 4-4. Appreciate how monetary policy changes affect key economic variables

-Inflation Example, see Bernstein book “Our main problem is to keep the rate of spending in line with the production of goods and servicesneither so low that prices and demand collapse nor so high that an inflationary spiral begins” -Peter Bernstein

-Banking Example (Bernstein Book)

1. Borrow money from a friend Deposits at Bank

Total

Before $ $ $ $

After $ $ $ $

1A. Alternative: Borrow money from a friend, who uses another bank. Deposits at Bank 1

Total

Deposits at Bank 2

Total

Before $ $ $ $

After $ $ $ $

Before $ $ $ $

After $ $ $ $

2. Purchase at a store (cash) Deposits at Bank Store Customer Total

Before $ $ $

After $ $ $

3. Purchase at a store (credit) Deposits at Bank Store Customer Credit Card Total

Before $ $ $ $

Step 1 $ $ $ $

Step 2 $ $ $ $

4. Store Pays Worker or a Supplier at different bank Deposits at Bank 1 Store Total

Deposits at Bank 2 Worker Supplier Total

Before $ $ $

After $ $ $

Before $ $ $ $

After $ $ $ $

Before $ $ $ $

After $ $ $ $

5. Bank makes a loan Deposits at Bank Store

Total

6. Initial Public Offering (IPO) Deposits at Bank Store (Issuer) Investor Total

Before $ $ $

After Sale of Securities $ $ $

7. Store sells government securities (T-Bonds), Bank buys government securities Deposits at Bank

Before

Store Buyer/Dealer ???? Total

$ $ $ $

After Sale of Securities After Bank Buys Secs. $ $ $ $ $ $ $ $

-Functions of the Fed LG 4-1. Understand the major functions of the Federal Reserve System 1. ___________________________________________ by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates (Note: The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals.)

2. ____________________________________________________ to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers

3. ___________________________________________________ and contain systemic risk that may arise in financial markets

4. _________________________________________________ and other financial services to depository institutions, the U.S. government, and foreign official institutions

-“Structure of the Federal Reserve System” LG 4-2. Identify the structure of the Federal Reserve System Three main components 1. 2. 3.

Federal Reserve Banks

Table 4-1 Functions Performed by the Federal Reserve Banks 1.

More Details

Operate discount window for banks

2.

Examine member banks, issue warnings about unsafe or unsound practices, approve mergers, etc.

3.

Implement federal laws intended to protect consumers by writing and interpreting regulations, reviewing bank compliance.

4.

Serve as the bank for the US Treasury (US government)

Example/Note

5.

Collect and replace currency

6.

Central check clearing system for US banks

7.

Operate Fedwire and Automate Clearing House (ACH)

8.

Staff of professional economists

Board of Governors of the Federal Reserve (aka Federal Reserve Board)

Federal Open Market Committee (FOMC) The major monetary policy-making body of the Federal Reserve System

Balance Sheet of Federal Reserve System

Assets US Treasury securities US Government agency securities Federal Reserve Loans to Domestic Banks (Discount window) Other Liabilities Depository institution reserves Currency outside banks Other

Dec 2004 $797B 85% 0.0% 0.0%

Dec 2008 $2,271 B 21% 0.8% 25%

March 2010 $2,339B 33% 53% 0.5%

March 2014 $4,29 0 54% 39% 0.0%

2.9% 85.8%

38% 37%

45% 38%

57% 28%

-“Monetary Policy Tools” LG 4-3. Identify the monetary policy tools used by the Federal Reserve Definition of fed funds rate: the interest rate on short-term funds transferred between financial institutions, usually for a period of one day Fed funds rate is a function of the supply and demand for federal funds among banks and the effects of the Fed’s trading through the FOMC Fed can only target and influence the federal funds rate, it cannot directly set the rate

Required Reserves and Excess Reserves

Three main monetary policy tools 1. Definition: purchases and sales of US government and federal agency securities by the Federal Reserve. These transactions typically occur in the U.S. Treasury securities market (an over-the-counter market in which traders are linked to each other electronically)

Three main monetary policy tools, continued 2. Definition: rate of interest Federal Reserve Banks charge on loans to financial institutions in their district

3. Definition: the portion of reserves the Federal Reserve requires banks to hold

Reserve Requirement Example

***Fed Policies Since Financial Crisis Quantitative Easing

Two basic approaches (see Fig 4-6 and Table 4-7) 1) Target the interest rate on reserves, a.k.a. fed funds rate

2) Target the quantity of reserves in the market

“The Federal Reserve, The Money Supply, and Interest Rates” LG 4-4. Appreciate how monetary policy changes affect key economic variables See Figure 4-5 and Table 4-6

1. Identify whether each Federal Reserve action is expansionary or contractionary (will increase or decrease the money supply). Circle the correct answer in each row. A. Fed Buys Securities (OMO)

Expansionary

Contractionary

B. Fed Sells Securities (OMO)

Expansionary

Contractionary

C. Fed Raises Reserve Ratio

Expansionary

Contractionary

D. Fed Lowers Reserve Ratio

Expansionary

Contractionary

E. Fed Lowers Discount Rate

Expansionary

Contractionary

F.

Expansionary

Contractionary

Fed Raises Discount Rate

2. Identify the impact of Expansionary Activities and Contractionary Activities on the following economic factors. Circle the correct answers in each row.

Expansionary Activities

Contractionary Activities

Impact on: A. Reserves

Increase

Decrease

Increase

Decrease

B. Money Supply

Increase

Decrease

Increase

Decrease

C. Interest Rates

Increase

Decrease

Increase

Decrease

D. Credit Availability (Quantity) E. Security Prices

Increase Increase

Decrease Decrease

Increase Increase

Decrease Decrease...