1. Understanding Movements in Bank Reserves

2. Introduction
The balance sheet of the Fed shows the movements of reserves in the system
Very complicated since many things can impact the level of reserves
Open Market operations and Discounting
Other entries may offset movements in reserves
The Fed does not control many of these items
US Treasury can add or absorb bank reserves through fiscal spending or tax revenue

3. Bank Reserve Equation The expanded view of reserve movements
A summary sheet for sources and uses of reserves
Useful for monitoring trends in reserves—fundamental framework of monetary control.

4. The Fed’s Balance Sheet
Every item on the balance sheet (asset or liability) has an effect on reserves
Total assets = total liabilities
Fed’s total liabilities include reserves—“bank deposits” in the Fed plus cash in bank vaults
Therefore, bank reserves must equal total Federal Reserve assets minus all other Fed liabilities
Anything affecting a Fed’s asset or liability must alter reserves, unless it is offset somewhere else in the balance sheet

5. Federal Reserve Float Arises in process of clearing checks
“Cash items in process of collection” (an asset) minus “deferred availability cash items” (liability).
The difference between the two is the “float”
The Fed credits the deposit (reserve) account of the bank sending a check for collection to the Fed before it debits the deposit (reserve) account of the bank on which the check is drawn.

6. Fed Float
Float can fluctuate considerably, either adding to or subtracting from reserves
Can cause serious short-term disruptions in bank reserves.
An increase (decrease) in float raises (lowers) bank reserves and the monetary base dollar-for-dollar.
Check 21

7. Federal Reserve Notes Outstanding
Liability to the Fed, but an asset to holder of the currency
The change in this account does not alter bank reserves—notes outstanding rises, bank deposits at Fed falls
If the public decides to hold more currency, then bank reserves are lowered.

8. Tax and Loan Accounts
Accounts held by the Treasury at commercial banks.
The result of its tax collections and bond sales.
Increases in these accounts does not increase reserves, but when they are transferred from the banking system to the Treasury’s account at the Fed, reserves fall.

9. U.S. Treasury Deposits
The “working balance” of the Treasury reflected in spending and tax revenues

10. Types of Open Market Operations
We have assumed that the Fed could control the volume of reserves by use of open market operations
However, the reserve equation demonstrates that other influences outside control of the Fed can affect reserves
These outside influences need to be forecasted and monitored to assist the Fed in controlling the level of reserves

11. Defensive Measure
Fed engages in open market operations aimed at defending a target level of reserves from “outside” influences.
If the FOMC learns that there will be a sudden heavy conversion of tax-and-loan accounts into Treasury balances at the Fed, it may order open market purchases to offset this drain of reserves.
Offset transitory changes in reserves which are trying to push level of reserves outside the range desired by the Fed
Extensive use of Repurchase Agreements as temporary injections or deletions of reserves

12. Dynamic Measures
Open market operations aimed at either increasing or deceasing the overall level of bank lending capacity by changing the level of bank reserves
“Take the initiative” to actively affect reserves.
Defensive far outnumber dynamic.

13. Monetary Base
What specific variable should the Fed attempt to control to regulate money supply?
Control variable (operating target) is the immediate objective of open market operations
It is suggested that the Fed should attempt to control the monetary base—total reserves plus currency held by the nonbank public.
Reserve equation can be altered to focus on the monetary base.

14. How Does the Treasury Finance Government Spending?
Collecting taxes
Borrowing from the non-bank public
Borrowing from the banking system
Borrowing from the Federal Reserve
Printing money

15. Collecting Taxes
Taxes are deposited in the Treasury’s tax and loan accounts at commercial banks.
The Treasury shifts the funds to a FRB.
The government spends the money collected.

16. Borrowing from the Non-bank Public
Treasury sells bonds to public

17. Borrowing from the Banking System
Banks fully loaned up
Have to dispose of other assets to buy the government securities.
Initially the money supply is decreased, but as the Treasury spends funds, the public’s money holdings are restored.
Banks have excess reserves
When the Treasury spends, individuals receive brand-new demand deposits.

18. Borrow from the Federal Reserve
Sells bonds to the Federal Reserve.
When the Treasury spends funds, the public winds up with more demand deposits and the banks with more reserves.
Modern version of printing money to pay the government’s bills.

19. Printing Money
The money supply and reserves increase.