Chapter 5

1. Chapter 5 CENTRAL BANKS AND THE CREATION OF MONEY

2. The Federal Reserve System • Board of Governors • Federal Reserve Banks • Member Banks • Federal Open Market Committee

3. Tools of Monetary Policy • Reserve Requirements • Open Market Operations • Open Market Repurchase Agreements • Discount Rate

4. Reserve Requirements • Fractional Reserve Banking System • Required reserve ratio • Demand deposits • Time deposits • Total reserves • Required reserves • Excess reserves

5. Open Market Operations • Fed purchases and sales of government securities • Fed purchases • Increase excess reserves • Increase new loans • Increase money supply • Fed sales • Decrease excess reserves • Decrease loans • Decrease money supply

6. Open Market Repurchase Agreements • Repurchase Agreement • Fed buys securities from a seller who agrees to repurchase them at a higher price on a certain date in the future. (Temporary increase in excess reserves.) • Reverse Repurchase Agreement • Fed sells securities and agrees torepurchase them at a higher price on a certain date in the future. (Temporary decrease in excess reserves.)

7. Discount Rate • Rate charged on loans from the Fed’s discount window. • Administratively set by Board of Governors • An increase in the discount rate discourages banks from borrowing from the Fed • A decrease in the discount rate encourages banks to borrow from the Fed

8. Different Uses of Money • Unit of Account • Numeraire • Medium of Exchange • Currency and demand deposits • Store of Value • Time deposits

9. Monetary Aggregates • Monetary Base: Currency in circulation • Currency and coins plus total reserves • M1 Money Supply • Currency plus demand deposits • M2 Money Supply • M1 plus short-term time deposits • M3 Money Supply • M2 plus long-term time deposits

10. Money Multiplier • Process by which changes in bank reserves generate larger changes in the money supply. • Size of Multiplier Influenced by: • Reserve requirement ratio • Public’s demand for cash • Banks’ willingness to make loans • Level of interest Rates

11. The Money Supply Process in an Open Economy • Foreign Exchange Market Intervention • The Fed’s purchase and sale of foreign currencies • Purchase of foreign currencies • Increases monetary base • Reduces value of the U.S. currency • Sale of foreign currencies • Decreases monetary base • Increases value of the U.S. currency

12. Central Banks Around the World • European Central Bank • Bank of England • Bank of Japan

13. European Central Bank (ECB) • Replaced central banks in the 11 countries participating in the European Economic Community • Structure of ECB is decentralized • Major Issues: Weakness of Euro • Major Aspects: Transparency • Policy objective: price stability

14. England: Bank of England • Primary Roles: Monetary Policy and Stability of Financial System • Bank of England Act (1998) • No longer under control of Exchequer • Management of Government debt • Policy objective: price stability • Independence • Transparency

15. Japan: Bank of Japan • Ministry of Finance • Bank of Japan Law (1998) • Independence • Transparency • Policy objective: price stability • Policy Board • TanKan Report