Monetary Policy
What is Monetary Policy? The actions of a central bank, currency board, or other regulatory committee, that determine the size and rate of growth of the money supply, which in turn affects interest rates.
What is Monetary Policy? USA: Federal Reserve is in charge
The Federal Reserve: Created in 1913 by President Wilson A central bank would supervise the activity of local banks, control loans, and regulate the money supply
The Fed’s Structure: A 7 member Board of Governors in Washington D.C. headed by Alan Greenspan Nominated by the President Confirmed by the Senate 14 year terms
The 12 District Banks: Boston New York Philadelphia Cleveland Richmond Atlanta Chicago St. Louis Minneapolis Kansas City Dallas San Francisco
The Tools of Monetary Policy: Open Market Operations (securities) The Discount Rate Reserve Requirements
Open Market Operations: specified by the Federal Open Market Committee purchases and sales of U.S. Treasury and federal agency securities
Interest Rates 1) Discount Rate:Commercial banks like Citizens borrow money from the local Fed Bank. That Fed bank charges Citizens interest for this loan. Expansionary Policy: rates are lowered Contractionary Policy: rates are increased
How does it work? Hello, Fed, we need to increase our reserves… Citizens President (local branch)
The Fed Delivers $, but charges interest! Federal Reserve Bank of Boston + interest
2) Federal Funds Rate The interest rate banks charge one another on overnight loans made out of their excess reserves. The Fed adjusts this to “stabilize” the economy. This rate affects the prime interest rate (the rate charged on loans to individuals and businesses)
Open Market Operations: Government securities are bought and sold on the open market T-bills: short term securities (less than a year) T-notes: intermediate securities (1-10 years) T-bonds: long term securities (10+ years)
Expansionary Policy: securities are bought in the open market Contractionary Policy: securities are sold in the open market Open Market Operations (con’t)
Reserve Requirements: The amount of reserves that a bank must have in its vault Why do this? The Fed can manipulate the RR in order to influence the ability of Commercial Banks, like Citizens, to lend.
Reserve Requirements (con’t) Ranges between 5%-15% Expansionary Policy: reserve requirements are lowered Contractionary Policy: reserve requirements are raised
Banks vs. Thrifts Commercial Banks: provide business firms with checking accounts (full service institutions) Thrifts: provide services to individuals and non-profit companies (Savings and Loans)
Banking: Assets vs. Liabilities?
What are assets vs. liabilities? Assets: For a bank, it’s their: Loans given to customers Their actual reserves
Asset to a bank = Paying off your loan w/ interest attached!
Why an asset? The bank earns MONEY on you!!
What are assets vs. liabilities? Liabilities: A Savings Account (a deposit is a liability for the bank)
Liability = Keeping a savings account in which the bank pays YOU interest!
Why a liability? The bank loses money because of you!
What is the FDIC? Federal Deposit Insurance Corporation (FDIC): insures deposits up to $100,000 Banks who offer this insurance to customers must belong to FDIC and pay insurance premiums
Medium of Exchange: you can sell your goods and services to anyone Standard of Value: provides a standard to judge by Store of Value: saved for future use without losing value Functions of Money
Three Kinds of Money *Currency: all U.S. currency is “legal tender” All U.S. currency is “fiat” money: money has its value because the government says so Coins: token money Paper Money *Checkbook Money *Traveler’s Checks
Token Money Token Money: money is worth more in the real world than the actual piece of money is worth…
What is the Money Supply? M1: total of currency, checkbook money and travelers checks in circulation M2: M1 + individual savings accounts, and money market funds M3: M2 + business and other large savings accounts L: M3 + savings bonds
Liquidity:
When you invest, consider: Liquidity: how easily can investment be converted into cash Risk: how safe is the investment Yield/Return: how much of a return will the investment bring (determined by interest rate)
Investment Options Savings Account: safe investment-low interest- liquid Money-Market: higher interest-flexibility-more liquid than CDs Certificate of Deposits: high interest-very little flexibility-low liquidity Treasury Bonds: low interest-very safe-not liquid at all Mutual funds: investment in stock market-less risk than stocks Stocks: high risk/high yield