Ngân hàng, tín dụng - Chapter 19: The instruments of central banking

Fed’s most important tool to alter reserves • About $3,200 billion worth of marketable government securities outstanding – Held by individuals, corporations, and financial institutions – Used by the US Treasury to borrow to finance budget deficits – The sale of government securities by the Treasury is independent of the Fed and may work counter to the Fed’s monetary policy

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1Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 19 The Instruments of Central Banking Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-2 Learning Objectives • Explain the level and determinants of reserve requirements • Understand the use of the discount window • Realize the importance and use of open market purchases and open market sales Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-3 Introduction • Bank lending and money supply are related by some multiple to the level of bank reserves • Federal Reserve exercises control over bank lending and money supply by altering the level of reserves in the system and influencing the deposit creation multiplier • Fed accomplishes these objectives by changing the reserve requirements and by changing the actual amount of reserves held 2Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-4 Reserve Requirements • Within limits established by Congress, Federal Reserve can specify reserve requirements banks and deposit- type institution must hold against deposits. • This applies even if the institution is not a member of the Federal Reserve • Reserves can be in form of vault cash or deposits in regional bank—do not earn interest Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-5 Reserve Requirements (Cont.) • Percentage of required reserves varies with type of account – Demand Deposits • Can range between 8% to 14% • 3% of the first $42.1 million of demand deposits • Currently set at 10% on deposits above $42.1 million – Business-owned time and savings deposits • Can range between zero to 9% • Currently set at 0% Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-6 Reserve Requirements (Cont.) • Effect of lowering the reserve requirement – Automatically increases all banks’ excess reserves – Increases demand deposit through multiple lending – However, the ultimate impact depends on banks desire to make loans— element of discretion – Expands the money supply 3Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-7 Reserve Requirements (Cont.) • Effect of raising the reserve requirement – Decrease banks’ excess reserves and may force them to take steps to correct a deficit reserve position – Restrains lending and deposit creation – Contracts the money supply Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-8 Reserve Requirements (Cont.) • Even without legal reserve requirements, banks would still need to hold cash reserves as vault cash or on deposit with Federal Reserve – Cash to meet customer withdrawals – Balances at Fed to clear checks – Without legal reserve requirements, it is likely the multiplier relationship between reserves and money supply may fluctuate considerably Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-9 Discounting and the Discount Rate • Discount rate—amount the Federal Reserve charges banks for a temporary loan of reserves to cover a deficiency • Ability to borrow means that a bank does not need to call in loans or sell securities (reduce money supply) to deal with a deficit • All depository institutions have access to borrowing at the discount window, even if not a member of the Fed 4Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-10 Discounting and the Discount Rate (Cont.) • Federal Reserve influences banks’ desire to borrow reserves by changing discount rate – Lower the rate—more borrowing, increase money supply – Raising the rate—less borrowing, decrease money supply • Actual borrowing (changes in money supply) depends on banks’ willingness to use this facility of the FED Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-11 Discounting and the Discount Rate (Cont.) • Quantity of discount lending – Central bank is the ultimate source of liquidity in the economy – Lender of last resort—Discount provision was originally established to permit banks to borrow from the Fed when threatened with cash drains – Discount facility should not be used too often to get banks out of reserve difficulties, primarily when a bank is temporarily short of cash Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-12 Discounting and the Discount Rate (Cont.) • Quantity of discount lending (Cont.) – Banks should manage affairs so they do not need to use discount facility very often – Discounting is a privilege, not a right – Banks are supposed to use discount facility because of need, not to make profit – Prior to 2003, the Fed used extensive administrative and surveillance procedures to prevent “abuse” 5Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-13 Discounting and the Discount Rate (Cont.) • Quantity of discount lending (Cont.) – However, under the new discount lending procedure, the Federal Reserve charges a penalty rate above short-term market rates – In return, the Fed removes conditions and restrictions for banks that qualify for primary credit – The intent of the new policy is to improve access to discount window borrowing by removing the negative connotation of borrowing from the Fed Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-14 Discounting and the Discount Rate (Cont.) • Quantity of discount lending (Cont.) – In March 2008, the Federal Reserve opened the discount window to investment banks – This expanded role of lender of last resort was aimed at preventing the collapse of Bear Stearns which would have lead to panic withdrawals from all financial institutions Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-15 Discounting and the Discount Rate (Cont.) • Discount Rate and Market Interest Rates – Discounting is discouraged when the rate is above other short-term rates, and encouraged when it is below – In some countries, the discount rate is often kept above short- term market rates—a penalty rate as a means of restraining excessive borrowing – In US, discount rate is usually below Treasury bill rate so Fed relies on surveillance to prevent “abuse of the privilege” 6Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-16 Discounting and the Discount Rate (Cont.) • Relationship between discount rate and other market interest rates – Discount rate is an “administered” rate, set by Fed – Weak linkage between discount rate and reserves and money supply – Figure 19.1 • Change in the discount rate generally occurs after a change in the Treasury bill rate or federal funds rate • Also shows, after January 2003, the new primary credit rate is now above the rate on three-month T-bill – Reactive rather than proactive tool Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-17 FIGURE 19.1 Movements in the discount rate tend to come after Treasury bill rates. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-18 Discounting and the Discount Rate (Cont.) • Relationship between discount rate and other market interest rates (Cont.) – “Announcement” effect • An unexpected change in discount rate will signal that the Fed desires to change monetary policy • The public, reacting to this expectation, takes action that causes the Fed’s desire to occur – Change in the discount rate usually confirms what is happening, but does not initiate it 7Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-19 Open Market Operations • Fed’s most important tool to alter reserves • About $3,200 billion worth of marketable government securities outstanding – Held by individuals, corporations, and financial institutions – Used by the US Treasury to borrow to finance budget deficits – The sale of government securities by the Treasury is independent of the Fed and may work counter to the Fed’s monetary policy Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-20 Open Market Operations (Cont.) • Open market operations—Buying and selling government securities to influence bank reserves – Purchase securities—expand reserves (money supply) – Sell securities—contract reserves (money supply) – Does not matter whether Fed sells/purchases government securities to/from a bank, other financial institution, or individual—same result, assuming the simple multiplier Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-21 Open Market Operations (Cont.) • Modifications to the simple multiplier discussed in appendix to Chapter 19 will impact the ultimate relationship between changes in reserves and the money supply • The Federal Reserve permits the market to set the purchase/sales price of government securities and, thereby, altering the rate of interest on that class of securities 8Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-22 Conducting Open Market Operations • The Federal Open Market Committee (FOMC) in Washington decides on general aims and objectives of monetary policy and sets monetary targets (bank reserves, money supply, and interest rates) • Buying/selling of government securities takes place at Federal Reserve Bank of New York • Located in the heart of the New York financial district Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-23 Conducting Open Market Operations (Cont.) • A day at the trading desk – Open Market Account manager keeps close contact with securities dealers to get the “feel of the market” and what is needed to meet targets – Uses the federal funds rate as a barometer of reserve supply relative to demand – Tries to predict expected currency movements that can affect reserve position of the banking system – Contacts the US Treasury to determine what is happening to Treasury balances in tax and loan accounts at commercial banks Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 19-24 Conducting Open Market Operations (Cont.) • A day at the trading desk (Cont.) – Based on FOMC targets and projected changes in reserve position of the banking system, decides on appropriate sales/purchases of government securities – If changes in bank reserves are considered to be temporary, the open market account manager will use repurchase agreement to offset these transitory reserve movement

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