Monetary Economics Monetary Policy and the Federal Reserve System. Gerald P. Dwyer November 2015

Transcription

1 Monetary Economics Monetary Policy and the Federal Reserve System Gerald P. Dwyer November 2015

2 Readings Purposes and Functions Read Chapters 1 3 carefully Chapter 5, Supervision and Regulation Modern Money Mechanics Broad outline, not details about various factors Next time, same material

3 Operations of Federal Reserve System Monetary Policy Bank Supervision and Regulation Payments System

4 Monetary Policy The Federal Reserve is given two goals Federal Reserve Act, Section 2A The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates.

5 M2 Is Most Common Measure of Money M2SL Billions of dollars

6 Growth Rate of Money Stock Percent per year dlm2

7 Consumer Prices Billions of dollars PCEPI

8 Economy Unemployment Rate

9 Real GDP Growth Rate

10 How Well Has Federal Reserve Done? Price stability Maximum employment Question is counter factual

11 How Can Federal Reserve Affect Inflation, Employment and GDP? Monetary policy tools Open market operations Discount rate Reserve requirements Recent introductions Interest on required and excess reserve balances Quantitative Easing Term Asset backed Securities Loan Facility Term Deposit Facility

12 Term Asset Backed Securities Loan Facility The Term Asset Backed Securities Loan Facility (TALF) is a funding facility that will help market participants meet the credit needs of households and small businesses by supporting the issuance of assetbacked securities (ABS) collateralized by loans of various types to consumers and businesses of all sizes. Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non recourse basis to holders of certain AAA rated ABS backed by newly and recently originated consumer and small business loans. The FRBNY will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS. The U.S. Treasury Department under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008 will provide $20 billion of credit protection to the FRBNY in connection with the TALF.

13 Term Deposit Facility Term deposits will facilitate the implementation of monetary policy by providing a new tool by which the Federal Reserve can manage the aggregate quantity of reserve balances held by depository institutions. Funds placed in term deposits are removed from the accounts of participating institutions for the life of the term deposit and thereby drain reserve balances from the banking system. Reserve Banks will offer term deposits through the Term Deposit Facility (TDF), and all institutions that are eligible to receive earnings on their balances at Reserve Banks may participate in the term deposit program.

14 Large Scale Asset Purchases The Federal Reserve buy various assets Mortgage backed securities Long term government securities

15 Federal Reserve Ownership of Securities 3000 Billions of dollars T bills T notes and bonds all Agency secs. MBS

16 Interest Rates on Treasury Bills, Federal Funds and Excess Reserves January 2000 to September Percent Per Year Treasury Bill Rate Federal Funds Rate 1 0 Excess Reserves Rate -1 1/1/00 4/1/01 7/1/02 10/1/03 1/1/05 4/1/06 7/1/07 10/1/08 1/1/10 4/1/11 7/1/12 10/1/13 Sources: Federal Reserve Board, Treasury

17 U.S. Banks Excess Reserves January 1984 to September 2015

18 U.S. Monetary Base January 2000 to October 2015 Billions of dollars AMBSL

19 What Is Monetary Base? Monetary base, roughly speaking, equals currency held by the public plus reserves held by banks B=C+R Monetary base equals the monetary liabilities of the Federal Reserve and the Treasury Monetary base also is known as high powered money

20 U.S. Money Stock January 2000 to September Billions of dollars M2SL

21 What Is Money Stock? Money held by the nonbank public Money most commonly is measured by M2 M2, roughly speaking, is currency held by the nonbank public plus deposits in banks held by the nonbank public M C D

22 How are Money Stock and Monetary Base Related? Money multiplier has been interpreted as how Federal Reserve actions affecting the monetary base then affect the money supply (money stock) Federal Reserve s actions > B > M The multiplier is determined by households, firms and banks demands for currency and reserves

23 Money Multiplier Can show in terms of t accounts or just simple algebra M C D B C R M Money multiplier m B

24 Money Multiplier Multiplier Can show M B m

25 m Money Multiplier Derived M B m C R C D

26 m Money Multiplier Derived M B C D m C R C D 1 c 1 m C R c r D D

27 U.S. Money Multiplier January 1959 to September 2014 Percent per year M2 Money Multiplier

28 Why Decrease in M2 Multiplier? The money multiplier has decreased because excess reserves have increased This is arithmetic Whose actions determine excess reserves?

29 Why Decrease in M2 Multiplier? The money multiplier has decreased because excess reserves have increased This is arithmetic Whose actions determine excess reserves? Banks Federal Reserve

30 Why Decrease in M2 Multiplier? The money multiplier has decreased because excess reserves have increased Federal Reserve is supplying more excess reserves Asset purchases by Federal Reserve Banks want to hold more excess reserves because Interest on excess reserves Higher interest than Treasury bills A way to obtain additional earnings Not all holders of short term funds can hold reserves at the Fed Banks borrow from those holders of short term funds and deposit the proceeds at the Fed

31 Interest Rates on Treasury Bills, Federal Funds and Excess Reserves January 2000 to September Percent Per Year Treasury Bill Rate Federal Funds Rate 1 0 Excess Reserves Rate -1 1/1/00 4/1/01 7/1/02 10/1/03 1/1/05 4/1/06 7/1/07 10/1/08 1/1/10 4/1/11 7/1/12 10/1/13 Sources: Federal Reserve Board, Treasury

32 Open market Purchases and Money Supply Open market purchases of assets by the Fed still can increase the nominal quantity of money As currently implemented with an interest rate on excess reserves greater than the Treasury bill rate, the purchases do not increase the nominal quantity of money For a bit more detail, see my blog post at for November 5, 2014

33 Historically Before the financial crisis, the Federal Reserve set a target federal funds rate and bought and sold securities at rates consistent with that rate Two different supply curves Fed funds rate and quantity of reserves Perfectly elastic and perfectly inelastic

34 Changes in Reserve Requirements Changes in reserve requirements tend to be relatively large and are sterilized Sterilized: effect on monetary base is counteracted by open market purchases or sales c 1 m c r

35 Discount Rate Discount rate is interest rate at which the Federal Reserve lends to banks Higher interest rate, everything else the same, means that banks want to borrow less Collateralized loans Discount rate generally tracks Federal Funds rate Before 2008, the Federal Funds rate was the primary way in which the Federal Reserve affected the banking system

36 Discount Rate and Fed Funds Rate

37 Discount Rate and Fed Funds Rate Why don t banks arbitrage discount rate when it has been less than Fed Funds rate?

38 Discount Rate and Fed Funds Rate Why don t banks arbitrage discount rate when it has been less than Fed Funds rate? Stigma of borrowing Moral suasion

39 Open Market Operations Federal Reserve buys and sells government securities U.S. Treasury securities Agency securities Sometimes in repo transactions As part of quantitative easing, buying mortgagebacked securities

40 Federal Reserve Ownership of Securities T bills T notes and bonds all Billions of dollars Agency secs. MBS

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43 Monetary Policy at the Zero Lower Bound The interest rate on excess reserves is 25 basis points The Federal Funds rate is below that The Treasury Bill rate also is below that Interest rate on Federal Funds and most other interest rates cannot be negative How conduct monetary policy at the zero lower bound for interest rates?

44 Quantitative Easing Buy assets besides short term Treasury securities Generally thought goal is to increase nominal quantity of money If that is the goal for the Fed, they are failing miserably

45 U.S. Money Stock January 2000 to September Billions of dollars M2SL

46 Quantitative Easing in the United States As implemented, would not expect nominal quantity of money to increase Fed provides a zero risk short term asset for banks acquiring reserve balances This increases excess reserves Not likely to result in increased lending, securities purchases or anything else

47 Quantitative Easing s Goals in the United States Increasing nominal quantity of money not an obvious goal and simply has increased at typical rate Other goals: Increase funding for mortgages Decrease long term interest rates and increase firms investment Lower return for low risk assets relative to riskier assets Increase private funds in riskier activities (risk channel)

48 Summary Monetary policy s goals in the United States include an inflation component and an employment output component How well the Federal Reserve has done is a matter of debate

49 Summary Monetary policy tools Open market operations Discount rate Reserve requirements Recent introductions Interest on required and excess reserve balances Large scale purchases of long term Treasury securities Purchases of mortgage backed securities Quantitative easing has affected monetary policy in important ways Arguably, Fed is engaging in credit allocation