Tài liệu Thị trường tài chính và các định chế tài chính_ Chapter 04 docx

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Chapter 4
Functions of the Fed
Financial Markets and Institutions, 7e, Jeff Madura
Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.
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Chapter Outline

Organization of the Fed

Monetary policy tools

Impact of technical factors on funds

Fed control of the money supply

Monetary Control Act of 1980

Global monetary policy
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Organization of the Fed

The Fed has five major components:

Federal Reserve district banks

Member banks

Board of Governors


Federal Open Market Committee (FOMC)

Advisory committees
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Organization of the Fed (cont’d)

Federal Reserve district banks

There are 12 Federal Reserve district banks

The NY bank is the most important

Commercial banks that become members of the Fed must
purchase stock in their district banks

Pays a maximum dividend of 6% annually

Each district bank has nine directors

Six elected by member banks; three appointed by the Board of
Governors

The nine directors appoint the president of the district bank

District banks clear checks, replace old currency, provide loans
to depository institutions, and conduct research
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Organization of the Fed (cont’d)

Member banks


All national banks are required to be members of the
Fed

State-chartered banks are not required to be
members

About 35% of all banks are members
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Organization of the Fed (cont’d)

Board of Governors

The Board of Governors consists of seven members

Each member is appointed by the President of the
U.S. and confirmed by the Senate

Members serve 14-year terms

Reduces political pressure

Terms are staggered so that one term expires in every even-
numbered year

Main roles:

Regulate commercial banks

Control monetary policy

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Organization of the Fed (cont’d)

Federal Open Market Committee (FOMC)

The FOMC consists of the seven members of the
Board of Governors plus the presidents of five Fed
district banks

NY plus four others on a rotating basis

Goals: promote high employment, economic growth,
and price stability

Achieved through control of the money supply

Decisions on changes in monetary policy are
forwarded to the Trading Desk (Open Market Desk)
at the NY Fed district bank
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Organization of the Fed (cont’d)

Advisory committees

The Federal Advisory Council consists of one member from
each district

Makes recommendations to the Fed about economic and banking
issues


The Consumer Advisory Council consists of up to 30 members

Represents the financial institutions industry and its consumers

The Thrift Institutions Advisory Council consists of
representatives of savings banks, S&Ls, and credit unions

Offers views on issues specifically related to thrift institutions
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Integration of Federal Reserve
Components
Advisory
Committee
Board of Governors
•
Regulates member
banks and BHCs
•
Sets reserve
requirements
Supervision
Federal Open
Market Committee
•
Conducts open
market operations
Federal Reserve
District Banks
•
Clear checks

•
Replace old currency
•
Provide loans to
depository institutions
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Monetary Policy Tools

Open market operations

The FOMC meets 8 times a year

At each meeting, the target money supply growth level and
interest rate level are determined

FOMC meeting agenda

Members receive the Beige Book two weeks prior to the meeting

Meeting is attended by the Board of Governors, the 12 presidents of
the district banks, and staff members

Staff members begin with presentations about current economic
conditions and recent economic trends

Next, each FOMC member can offer recommendations about
whether monetary growth and interest rate target levels should be
changed

Last, voting members vote on monetary policy and interest rates

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Monetary Policy Tools (cont’d)

Open market operations (cont’d)

Communication to the Trading Desk

The FOMC’s decision on target money supply levels is
forwarded to the Trading Desk at the NY district bank through
a policy directive

FOMC objectives are specified in a target range for the
money supply growth

The FOMC also specifies a desired target for the federal
funds rate

The federal funds rate is the rate charged by banks on short-
term loans to each other
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Monetary Policy Tools (cont’d)

Open market operations (cont’d)

Role of the Trading Desk

The manager of the Trading Desk instructs traders on the amount of
government securities to buy or sell in the secondary market

This is called open market operations


The Trading Desk continuously conducts open market operations in
response to ongoing changes in bank deposit levels
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Monetary Policy Tools (cont’d)

Open market operations (cont’d)

Fed purchase of securities

Traders at the Trading Desk call government securities
dealers to purchase securities

Dealers provide a list of securities for sale

Traders purchase those that are most attractive

The total funds of commercial banks increase by the dollar
amount of securities purchased by the Fed

A loosening of the money supply

To force a decline in the Fed funds rate, the Trading Desk
can also purchase Treasury securities

The Fed funds rate will decline along with other interest rates
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Monetary Policy Tools (cont’d)

Open market operations (cont’d)


Fed sale of securities

To decrease the money supply, traders sell government
securities to government securities dealers

Sold to the dealer submitting the highest bid

As dealers pay, their account balances are reduced and the
total amount of funds at commercial banks is reduced

A tightening of the money supply

To force an increase in the Fed funds rate, the Trading Desk
can also sell Treasury securities
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Monetary Policy Tools (cont’d)

Open market operations (cont’d)

Fed use of repurchase agreements

Used to increase the aggregate level of bank funds for only a few
days

The Trading Desk trades repurchase agreements rather than
government securities

Purchases Treasury securities with an agreement to sell back
the securities at a specified date in the near future


Often used during holidays to correct temporary imbalances
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Monetary Policy Tools (cont’d)

Open market operations (cont’d)

How open market operations affect interest rates

When the Fed uses open market operations to increase bank
funds, interest rates are affected because:

The fed funds rate may decline

Banks with excess funds may offer new loans at a lower
interest rate

Banks may lower interest rates on deposits

The yield on Treasury securities may decline
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Monetary Policy Tools (cont’d)

Open market operations (cont’d)

How open market operations affect interest rates
(cont’d)

As yields on bank deposits and Treasuries decline, investors
look for alternative securities


The yields on the alternative investments will decline as
more money is invested in them

The reduction in yields on debt securities lowers the cost of
borrowing for the issuers of debt securities

Can encourage potential expenditures
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Monetary Policy Tools (cont’d)

Open market operations (cont’d)

Dynamic vs. defensive open market operations

Dynamic operations are implemented to increase or decrease the
level of funds

Defensive operations offset the impact of other conditions that
affect the level of funds
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Monetary Policy Tools (cont’d)

Open market operations (cont’d)

Open market operations in response to the Crash

Stock prices declined by 22 percent on October 19, 1987

The Fed loosened the money supply to provide liquidity


The Fed monitored bank deposits to ensure there was no run on
deposits

The Fed monitored credit relationships between commercial
banks and securities firms

Open market operations in response to the weak
economy in 2001

The Fed increased money supply growth to stimulate the
economy

Businesses did not respond to lower interest rates
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Monetary Policy Tools (cont’d)

Open market operations (cont’d)

Open market operations in response to the
September 11 attack on the United States

The FOMC decided to add liquidity to the banking system to
prevent a banking crisis

The FOMC left the federal funds rate target unchanged

On September 17, the FOMC reduced the federal funds
target rate by 50 basis points just before markets reopened
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Monetary Policy Tools (cont’d)

Adjusting the discount rate

To increase the money supply, the Fed can authorize
a reduction in the discount rate

Encourages depository institutions to borrow from the Fed

To decrease the money supply, the Fed can increase
the discount rate

Discouraged borrowing from the Fed
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Monetary Policy Tools (cont’d)

Adjusting the discount rate (cont’d)

In January 2003 the Fed classified its loans as
primary or secondary credit

Primary credit can be used for any purpose but it available only to
financially sound institutions

Secondary credit is provided to banks that do not qualify for
secondary credit

Contains a risk premium above the discount rate
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Monetary Policy Tools (cont’d)


Adjusting the discount rate (cont’d)

Recently, the Fed has often adjusted the discount rate
to keep it in line with changes in the targeted federal
funds rate

In January 2003, the Fed set the discount rate at a
level above the federal funds rate

Loans from the Fed serve as a backup source of funds

The discount rate no longer serves as a signal about the
Fed’s monetary policy
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Monetary Policy Tools (cont’d)

Adjusting the reserve requirement ratio

The reserve requirement ratio is the proportion of
bank deposits that must be held as reserves

Set by the Board of Governors

Historically set between 8 and 12 percent

Currently 10 percent of transaction accounts

Sometimes changed to adjust the money supply


A reduction increases the proportion of bank deposits that can
be lent out
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Monetary Policy Tools (cont’d)

Adjusting the reserve requirement ratio
(cont’d)

How reserve requirement adjustments affect money
growth

An initial increase in demand deposits as a result of loosening the
money supply multiplies into (1/reserve requirement ratio)

A higher ratio causes an initial injection to multiply by a smaller
amount