Mishkin-10-C15-Tools-of-Monetary-Policy

Chapter15ToolsofMonetaryPolicy©2013PearsonEducation,Inc.Allrightsreserved.15-2TheMarketForReservesandtheFederalFundsRate•DemandandSupplyintheMarketforReserves•Whathappenstothequantityofreservesdemandedbybanks,holdingeverythingelseconstant,asthefederalfundsratechanges?•Excessreservesareinsuranceagainstdepositoutflows–Thecostofholdingtheseistheinterestratethatcouldhavebeenearnedminustheinterestratethatispaidonthesereserves,ier©2013PearsonEducation,Inc.Allrightsreserved.15-3DemandintheMarketforReserves•Sincethefallof2008theFedhaspaidinterestonreservesatalevelthatissetatafixedamountbelowthefederalfundsratetarget.•Whenthefederalfundsrateisabovetheratepaidonexcessreserves,ier,asthefederalfundsratedecreases,theopportunitycostofholdingexcessreservesfallsandthequantityofreservesdemandedrises•Downwardslopingdemandcurvethatbecomesflat(infinitelyelastic)atier©2013PearsonEducation,Inc.Allrightsreserved.15-4SupplyintheMarketforReserves•Twocomponents:non-borrowedandborrowedreserves•CostofborrowingfromtheFedisthediscountrate•BorrowingfromtheFedisasubstituteforborrowingfromotherbanks•Ififfid,thenbankswillnotborrowfromtheFedandborrowedreservesarezero•Thesupplycurvewillbevertical•Asiffrisesaboveid,bankswillborrowmoreandmoreatid,andre-lendatiff•Thesupplycurveishorizontal(perfectlyelastic)atid©2013PearsonEducation,Inc.Allrightsreserved.15-5Figure1EquilibriumintheMarketforReserves©2013PearsonEducation,Inc.Allrightsreserved.15-6HowChangesintheToolsofMonetaryPolicyAffecttheFederalFundsRate•Effectsofopenanmarketoperationdependsonwhetherthesupplycurveinitiallyintersectsthedemandcurveinitsdownwardslopedsectionversusitsflatsection.•Anopenmarketpurchasecausesthefederalfundsratetofallwhereasanopenmarketsalecausesthefederalfundsratetorise(whenintersectionoccursatthedownwardslopedsection).©2013PearsonEducation,Inc.Allrightsreserved.15-7HowChangesintheToolsofMonetaryPolicyAffecttheFederalFundsRate(cont’d)•Openmarketoperationshavenoeffectonthefederalfundsratewhenintersectionoccursattheflatsectionofthedemandcurve.©2013PearsonEducation,Inc.Allrightsreserved.15-8HowChangesintheToolsofMonetaryPolicyAffecttheFederalFundsRate(cont’d)•Iftheintersectionofsupplyanddemandoccursontheverticalsectionofthesupplycurve,achangeinthediscountratewillhavenoeffectonthefederalfundsrate.•Iftheintersectionofsupplyanddemandoccursonthehorizontalsectionofthesupplycurve,achangeinthediscountrateshiftsthatportionofthesupplycurveandthefederalfundsratemayeitherriseorfalldependingonthechangeinthediscountrate©2013PearsonEducation,Inc.Allrightsreserved.15-9HowChangesintheToolsofMonetaryPolicyAffecttheFederalFundsRate(cont’d)•WhentheFedraisesreserverequirement,thefederalfundsraterisesandwhentheFeddecreasesreserverequirement,thefederalfundsratefalls.©2013PearsonEducation,Inc.Allrightsreserved.15-10Figure2ResponsetoanOpenMarketOperation©2013PearsonEducation,Inc.Allrightsreserved.15-11Figure3ResponsetoaChangeintheDiscountRate©2013PearsonEducation,Inc.Allrightsreserved.15-12Figure4ResponsetoaChangeinRequiredReserves©2013PearsonEducation,Inc.Allrightsreserved.15-13Figure5ResponsetoaChangeintheInterestRateonReserves©2013PearsonEducation,Inc.Allrightsreserved.15-14Figure6HowtheFederalReserve’sOperatingProceduresLimitFluctuationsintheFederalFundsRate©2013PearsonEducation,Inc.Allrightsreserved.15-15ConventionalMonetaryPolicyTools•Duringnormaltimes,theFederalReserveusesthreetoolsofmonetarypolicy—openmarketoperations,discountlending,andreserverequirements—tocontrolthemoneysupplyandinterestrates,andthesearereferredtoasconventionalmonetarypolicytools.©2013PearsonEducation,Inc.Allrightsreserved.15-16OpenMarketOperations•Dynamicopenmarketoperations•Defensiveopenmarketoperations•Primarydealers•TRAPS(TradingRoomAutomatedProcessingSystem)•Repurchaseagreements•Matchedsale-purchaseagreements©2013PearsonEducation,Inc.Allrightsreserved.15-17AdvantagesofOpenMarketOperations•TheFedhascompletecontroloverthevolume•Flexibleandprecise•Easilyreversed•Quicklyimplemented©2013PearsonEducation,Inc.Allrightsreserved.15-18DiscountPolicyandtheLenderofLastResort•Discountwindow•Primarycredit:standinglendingfacility–Lombardfacility•Secondarycredit•Seasonalcredit•Lenderoflastresorttopreventfinancialpanics–Createsmoralhazardproblem©2013PearsonEducation,Inc.Allrightsreserved.15-19AdvantagesandDisadvantagesofDiscountPolicy•Usedtoperformroleoflenderoflastresort–Importantduringthesubprimefinancialcrisisof2007-2008.•CannotbecontrolledbytheFed;thedecisionmakeristhebank•Discountfacilityisusedasabackupfacilitytopreventthefederalfundsratefromrisingtoofarabovethetarget©2013PearsonEducation,Inc.Allrightsreserved.15-20ReserveRequirements•DepositoryInstitutionsDeregulationandMonetaryControlActof1980setsthereserverequirementthesameforalldepositoryinstitutions•3%ofthefirst$48.3millionofcheckabledeposits;10%ofcheckabledepositsover$48.3million•TheFedcanvarythe10%requirementbetween8%to14%©2013PearsonEducation,Inc.Allrightsreserved.15-21DisadvantagesofReserveRequirements•Nolongerbindingformostbanks•Cancauseliquidityproblems•Increases