Tài chính doanh nghiệp - The tools and goals of central bank monetary policy

Money and Capital Markets14C h a p t e rEighth EditionFinancial Institutions and Instruments in a Global MarketplacePeter S. RoseMcGraw Hill / IrwinSlides by Yee-Tien (Ted) FuThe Tools and Goals of Central Bank Monetary Policy Learning Objectives To understand how the policy tools available to central banks work in carrying out a nation’s money and credit policies.To explore the strengths and weaknesses of the various monetary policy tools.To learn how the Federal Reserve System controls U.S. credit and interest rate levels.To see how central bank policy actions affect a nation’s economic goals.IntroductionCentral banks are given the task of regulating the money and credit system in order to achieve the economic goals of full employment, a stable price level, sustainable economic growth, and a stable balance-of-payments position with the rest of the world.Although these objectives are not easy to achieve and often conflict, the central bank has powerful policy tools at its disposal.General versus Selective Credit ControlsGeneral credit controls affect the entire banking and financial system.Examples: reserve requirements, the discount rate, open market operationsSelective credit controls affect specific groups or sectors of the financial system.Examples: moral suasion, margin requirements on the purchase of listed securitiesReserve RequirementsIn the U.S., all depository financial institutions (including nonmembers) are required to conform to the deposit reserve requirements set by the Fed.Changes in reserve requirements are a very potent, though little-used tool.Indeed, reserve requirements have recently been reduced in the U.S., and eliminated in Canada, New Zealand, and the U.K.Reserve RequirementsCurrent Levels of Reserve Requirementsfor Depository Institutions in the U.S.Source: Board of Governors of the Federal Reserve System, October 2001Reserve RequirementsAn increase in deposit reserve requirementsdecreases the deposit and money multipliers, slowing the growth of money, deposits and loansreduces the amount of excess legal reserves - institutions deficient in required legal reserves will have to sell securities, cut back on loans, or borrow reservesincreases interest rates, particularly in the money market, as depository institutions scramble to cover any reserve deficienciesThe Discount RateThe discount rate is the annual percentage interest charge levied against those institutions choosing to borrow reserves from the discount window of the Federal Reserve bank in its region.Frequent borrowing is discouraged and may be penalized with a higher interest rate.The Discount RateAn increase in the discount ratereduces the volume of loans from the discount window (cost effect)makes borrowing from the Fed less attractive (substitution effect)signals that the Fed is pushing for tighter credit conditions (announcement effect), and market participants may respond by curtailing their spending plans or by accelerating their borrowings (to secure the credit they need before interest rates move even higher - negative psychological effect)The Discount RateSince the middle of 1999, the Fed’s discount rate has followed the Federal funds interest rate.Typically, the discount rate has been set half-a-point lower than the Federal funds rate, so as to turn the discount rate and the discount window into a passive tool in the conduct of U.S. monetary policy.The Discount RateSource: April 2002Note: Intended federal funds rate effective 12/11/2001 = 1.75%14 - 11Open Market OperationsOpen market operations in the U.S. consist of the buying and selling of U.S. government and other securities by the Federal Reserve System to affect the quantity and growth of legal reserves, and ultimately, general credit conditions.Open market operations are a most flexible policy tool, suitable for fine-tuning the financial markets.Open Market OperationsThe open market tool has two major effects.When the Fed is purchasing securities, the additional demand for the securities in the market tends to increase their prices and lower their yields, so interest rates decline.A Federal Reserve purchase of government securities increases the reserves of the banking system and expands its ability to make loans and create deposits, thereby increasing the growth of money and credit.Types of Federal Reserve Open Market TransactionsOutright or Straight Open Market Transaction(permanent change in the level of reserves held by depository institutions)FederalReservebankFed buys securitiesDealerDealer’s bankSecuritiesReservesFederalReservebankFed sells securitiesDealerDealer’s bankSecuritiesReservesTypes of Federal Reserve Open Market TransactionsRP or Reverse RP Transaction(temporary change in the level of reserves held by depository institutions)RP: Fed buys securities temporarilyFederalReservebankDealerDealer’s bankSecuritiesReservesLater on:ReservesSecurities returnedReverse RP: Fed sells securities temporarilyFederalReservebankDealerDealer’s bankSecuritiesReservesLater on:ReservesSecurities returnedTypes of Federal Reserve Open Market TransactionsRun-Off Transaction(permanent reduction in the level of reserves held by depository institutions)FederalReservebankSells more securities to raise more cashPays cashTreasuryMaturing Treasury securitiesDealerDealer’sbankOrders bank to pay for the new securitiesReservesTypes of Federal Reserve Open Market TransactionsAgency Transaction (Type A)(no change in the total level of reserves held by all depository institutions)FederalReservecustomerPlaces order for securities through a Federal Reserve bank which then contacts dealerDelivers securitiesDealerDealer’sbankOrders payment to dealerReservesCustomer’sbankTypes of Federal Reserve Open Market TransactionsAgency Transaction (Type B)(permanent reduction in the level of reserves held by depository institutions)FederalReservecustomerPlaces order for securitiesSecurities delivered from Fed’s own portfolioFederalReservebankOrders payment to FedReservesCustomer’sbankOpen Market OperationsDefensive open market operations are technical adjustments in market conditions to preserve the status quo and to maintain the present pattern of interest rates and credit availability.In contrast, dynamic open market operations are designed to upset the status quo and to change interest rates and credit conditions to a level the Fed believes to be more consistent with its economic goals.Selective Credit Controls Used by the FedMoral suasion refers to the use of “arm-twisting” or “jawboning” by central bank officials to encourage lending institutions and the public to conform with the spirit of its policies.Selective Credit Controls Used by the FedMargin requirements on the purchase of stocks and convertible bonds and on short sales of securities limit the amount of credit that can be used as collateral for a loan.Since 1974, the U.S. margin requirement on stocks, convertible bonds, and short sales has been 50% of the market value of the securities.Interest Rate TargetingIn recent years, the Federal Reserve has given increasing weight to targeting the cost and availability of credit in the money market (in particular, the daily average interest rate on federal funds transactions).The Fed achieves its target through open market operations that impact primarily the nonborrowed reserves (and hence the total reserves) available to the banking system.Interest Rate TargetingD’When the demand for reserves S’The Fed supplies more reservesSuch that the federal funds rate is maintained at the desired levelE’Federal Funds Interest Rate (%)Supply of Reserves ($)DSEMonetary Policy TargetsOperating Targets(borrowed & nonborrowed reserves)Instrumental Targets(the federal funds rate & the growth of total reserves)Intermediate Targets(money & credit growth & long-term interest rates)Final Targets(low unemployment & inflation, sustainable economic growth, & a stable international balance-of-payments position)The Federal Reserve and Economic GoalsThe Goal of Controlling InflationInflation creates undesirable distortions in the allocation of scarce resources.In the 1990s, several central banks (such as New Zealand, Canada, and U.K.) began setting target inflation rates or rate ranges.The U.S. has not set an explicit inflation rate target – it pursues price stability and full employment simultaneously.The Federal Reserve and Economic GoalsThe Goal of Full EmploymentThe Employment Act of 1946 committed the U.S. government to minimizing unemployment as a major national goal.The Federal Reserve and Economic GoalsThe Goal of Sustainable Economic GrowthThe Federal Reserve has declared that one of its most important long-term goals is to keep the economy growing at a relatively steady and stable rate – that is, a rate high enough to absorb increases in the labor force and prevent the unemployment rate from rising but slow enough to avoid runaway inflation.The Federal Reserve and Economic GoalsEquilibrium in the U.S. Balance of Payments and Protecting the DollarIn the international sector, the Fed pursues two interrelated goals:protecting the value of the dollar in foreign currency markets, andachieving an equilibrium position in the U.S. balance of payments.The Trade-offs Among Economic GoalsEconomic goals conflict.For example, controlling inflation and stabilizing the U.S. international payments situation (sizable trade deficits) usually require the Fed to slow down the economy through restricted money supply growth and higher interest rates.However, this policy threatens to generate more unemployment and subdue economic growth.The Trade-offs Among Economic GoalsHowever, there is growing research evidence that full employment and price stability (the absence of serious inflation) are compatible with each other in the longer term.This definition of sustainable long-run full employment is often referred to by economists as the NAIRU – the non-accelerating inflation rate of unemployment.The Limitations of Monetary PolicyCentral banks cannot completely control financial conditions or the money supply.Changes in the economy feed back on the money supply and the financial markets.The structure of the economy is changing due to deregulation, internationalization, technological developments, etc., such that changes in domestic interest rates are probably not as potent a factor affecting the economy as they were a decade ago.Money and Capital Markets in CyberspaceMost central banks maintain comprehensive websites, including information on what tools they normally use to carry out their money and credit policy. Visit, for example, ReviewIntroductionGeneral versus Selective Credit ControlsGeneral Credit Controls of the FedReserve RequirementsThe Discount RateOpen Market OperationsSelective Credit Controls Used by the FedMoral Suasion by Central Bank OfficialsMargin RequirementsChapter ReviewInterest Rate TargetingThe Federal Funds RateThe Federal Reserve and Economic GoalsThe Goal of Controlling InflationThe Goal of Full EmploymentThe Goal of Sustainable Economic GrowthEquilibrium in the U.S. Balance of Payments and Protecting the DollarChapter ReviewThe Trade-offs Among Economic GoalsThe Limitations of Monetary Policy