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Federal Reserve

Federal Reserve. Economics 71a Spring 2007 Mayo, Chapter 5 (skim) Lecture notes 2.5. Federal Reserve. Goals Stable prices Full employment Growth Tools Monetary policy Bank regulation. Money Growth and Inflation “Why monetary policy is tricky”. (Money growth) > (Economic growth)

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Federal Reserve

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  1. Federal Reserve Economics 71a Spring 2007 Mayo, Chapter 5 (skim) Lecture notes 2.5

  2. Federal Reserve • Goals • Stable prices • Full employment • Growth • Tools • Monetary policy • Bank regulation

  3. Money Growth and Inflation“Why monetary policy is tricky” • (Money growth) > (Economic growth) • Inflation • (Money growth) < (Economic growth) • Deflation • Getting this right is tricky

  4. The Federal Reserve and the Money Supply • The Fed does not set the money supply • Indirect tools • Reserve requirements • Discount rate • Open market operations • All are only indirect

  5. Reserve Requirements • Deposit $100 in bank • Bank must keep % (reserve) in vault • Loans out rest • Example 10%: Keep $10 (reserve), loan $90 • This $90 ends up at another bank • Keep $9, loan $81 • Money multiplier • Reducing the reserve requirement has big positive impact on the money supply • Rarely done

  6. Discount Rates • Banks can borrow reserves from the Fed • Interest rate Fed charges banks is called the discount rate • Reducing this increases reserves and also the money supply • Federal funds rate • Related interest rate • Interest banks charge eachother (bank to bank) • Only discount rate is set by Federal Reserve

  7. Open Market Operations • Federal reserve buys and sells government securities • Purchasing government bonds • Increases money supply • Reduces interest rates • Selling government bonds • Decreases money supply • Increase interest rates

  8. How Does this Market Work? • Treasury bill (Tbill) • Treasury bill pays $102 in 90 days • Price today is $100 • Interest = 2% • Federal reserve starts buying • Price goes up to $101 • Interest (102-101)/101 = approx 1%

  9. Monetary Targets • Money supply • Interest rates • Inflation rates

  10. The Federal Reserve and Financial Markets • Not really in its jurisdiction • Clearly linked to banking and monetary system • Should the Federal Reserve care about what is going on in other financial markets? • Can movements in other markets impact the “money supply”? (Stock market, Real estate) • Federal Reserve does worry about systemic risk

  11. Summary • Monetary policy is difficult • Tools are not precise • Don’t get to set the money supply • Interactions with financial markets (both local and globally) are important

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