LECTURE MATERIAL FOR CHAPTER 13

 

DEFINITION:

MONEY is anything that is generally accepted as final payment for goods, services, and debt.

 

 

 

 

 

 

 

 

 

 

 

MEDIA OF EXCHANGE

1. Currency (including coins)

2. Checkable deposits at financial intermediaries (primarily banks)

a. Demand deposits

b. NOW account deposits

c. Credit Union share draft deposits

3. Traveler's checks

4. Some other items to a limited degree

Example: Money Market Mutual Fund shares

 

 

 

DEPOSITORY FINANCIAL INSTITUTIONS

1. COMMERCIAL BANKS

a. National Banks

b. State Banks

2. Savings and Loan Associations

3. Savings Banks

4. Credit Unions

 

We will use the generic term "bank" to refer to all of these depository financial institutions.

 

 

 

 

 

 

 

 

 

M1 = C + D

C = Currency held by the non-bank public

Coins

Paper money

D = Checkable deposits held by the non-bank public

Demand deposits

NOW account deposits

Credit Union share draft deposits

 

M2 = M1 + Additional items

 

 

 

 

 

DEFINITION:

A CENTRAL BANK is an institution that oversees and regulates the banking system and conducts monetary policy.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ASSETS LIABILITIES + NET WORTH

 

 

 

 

 

 

 


Figure L13-1

 

 

 

 

 

 

 

 

rr =

rr = Required Reserve Ratio

RR = Required Reserves

D = Checkable Deposits

 

Therefore:

RR = rr x D

 

Other abbreviations:

R = Reserves (That is, total reserves).

ER = Excess Reserves = R - RR

 

 

 

 

 

 

 


FIGURE L13-2

 

 

 

 

 



FIGURE L13-3

 

 

 

 

 

 

 

 


FIGURE L13-4

 

 

 

 

 

 

 

 


FIGURE L13-5

 

 

 

 

 

 

 

FIGURE L13-6

 

 

 

 

 

 

 

 

 

FIGURE L13-7A

FIGURE L13-7B

 

 

 

 

 

 

 

 

 

 

 


FIGURE L13-8

 

 

 

 

 

 


FIGURE L13-9

 

 

 

 

 

 

 

 

 

 

 

 

 

B = C + R

Where

B = Monetary Base

 

 

 

 

 

 

 

 

 

The complete M1 money multiplier equation:

 

Where

 

 

 

 

 

 

 

HOW THE FED ACTUALLY CONDUCTS MONETARY POLICY AT THE PRESENT TIME:

 

At the present time the Fed engages in monetary policy by controlling one particular interest rate:

The federal funds rate.

Recall that the federal funds rate is the rate of interest banks have to pay when they borrow reserves from other banks in the federal funds market.

The federal funds rate is the rate for overnight loans of bank reserves.

The federal funds market is a market for bank reserves.

The federal funds market is a highly competitive market, and the federal funds rate is determined by the supply and demand for bank reserves.

The Federal Reserve System is able to move the federal funds rate up and down by changing the supply of bank reserves.

THE WAY THAT THE FED CURRENTLY CONDUCTS MONETARY POLICY IS THEREFORE AS FOLLOWS:

The Federal Open Market Committee (FOMC) sets a target rate for the federal funds rate.

The actual open market operations are carried out by the trading desk at the Federal Reserve Bank of New York.

It is the responsibility of the Manager of the System Open Market Account to bring the actual federal funds rate very close to the target.

The Manager of the System Open Market Account does this through the Trading Desk, which makes the open market purchases and sales.

Under the direction of the Manager of the System Open Market Account, the Trading Desk does the following:

If the actual federal funds rate is below the target rate, the trading desk engages in open market sales.

This reduces the supply of bank reserves, which raises the actual federal funds rate. It does this until the actual federal funds rate is equal to the target rate.

If the actual federal funds rate is above the target rate, the trading desk engages in open market purchases.

This increases the supply of bank reserves, which lowers the actual federal funds rate. It does this until the actual federal funds rate is equal to the target rate.

Using this method, the Fed can bring the actual federal funds rate very close to the target rate.

When the FOMC changes the federal funds rate target, the Manager of the System Open Market Account, working through the Trading Desk, must then use open market operations to bring the actual federal funds rate to the new target, which it can do in a short period of time.

Other interest rates move up and down with the federal funds rate.

Short-term rates follow the federal funds rate very closely.

Long-term rates follow it much less closely and can sometimes move in the opposite direction.

Data on some interest rates.

 

 

 

 

Note that the open market operations, made for the purpose of bringing the actual federal funds rate in line with the target rate, still alter the money supply.

Since the open market purchases increase the monetary base, they bring about a multiple expansion of the money supply.

Since the open market sales decrease monetary base, they bring about a multiple contraction of the money supply.

But the changes in the money supply are now a side-effect of a policy whose objective is to control the federal funds rate, rather than being the objective that the Fed is seeking to achieve.

Note that while this is the way the Fed is CURRENTLY conducting monetary policy, this has not always been the way it has conducted it in the past, and may not be the way it conducts it in the future.