The Federal Reserve System and the
Money Supply Process
Chaps 13-14 (9th edition), Mishkin
1
I.
Goals of monetary policy (in order of priority)
1.
2.
3.
4.
5.
6.
2
II.Brief structure of the FED
The FEDERAL RESERVE SYSTEM consists of:
1. 12 regional Federal Reserve Banks (FRB’s) which have jurisdiction
over the 12 Federal Reserve districts into which the country is
divided.
Main functions are,
(i) ____________
(ii) ____________
(iii) ____________
(iv) ____________
2. The Board of Governors (BOG)
7 members appointed by the President, each serving one full
nonrenewable 14-year plus part of another term (if coming in place
of someone else)
chairman serves 4-year renewable terms
3
3. The Federal Open Market Committee (FOMC)
meets about every 6 weeks, determines and conducts monetary policy
consists of 7 BOG members + president of the New York FRB + 4
presidents chosen from the other FRBs (the other 7 presidents participate
but do not vote)
Three tools of monetary policy are
(i) ___________
(ii) ___________
(iii) ___________
4
Assets
Reserves
$10m
Loans
Securities
$90 m
$10 m
Liabilities
Deposits
$100 m
Bank capital $10 m
Q1. Suppose the FED purchases 5m worth of T-bonds from banks
(Open market purchase). How does this affect the balance sheet of the
bank?
Q2. Suppose the FED sells off 5m worth of T-bonds to banks (Open
market sale). How does this affect the balance sheet of the bank?
Conclusion: Open market purchase ________ cash reserves of banks.
Open market sale _______ cash reserves of banks.
5
I. The Fed’s balance sheet
Mark as an asset or liability:
1. Securities (US govt. and agency, banker’s acceptances)
2. Notes in circulation ($ bills)
3. Discount loans
4. Bank deposits (also known as bank reserves)
6
II. The monetary base (MB) of an economy
The monetary liabilities of the FED, sometimes also referred to as the
FED’s monetary liabilities to the private sector =
US Treasury’s monetary liabilities to the private sector =
The Monetary Base (MB) of an economy =
=
In symbols, MB = C + R, where C =
R=
MB is also described as high powered money.
7
FED controls MB directly through open market operations and
discount loans. The immediate effect of an open market purchase of
$100 from banks create the following changes in the T-accounts of the
banking system and the FED
The Banking System
Assets
Liabilities
Securities
Reserves
The Fed
Assets
Securities
Liabilities
Reserves (or notes)
What happens to the total reserves and the monetary base of the
economy? What happens if there is a open market sale?
8
The immediate effect of new discount loans made by the FED to
the banks is,
Banking System
Assets
Liabilities
Reserves
Discount
loan
The Fed
Assets
Discount
loan
Liabilities
Reserves or notes
What is the effect on R and MB?
What happens if the bank pays off some of its loans to the FED?
9
Suppose the FED makes the purchase from the non-bank public and
pays for it with a check. The check is deposited at a local bank.
Non Bank Public
Assets
Liabilities
Securities
Deposits
The Fed
Assets
Securities
Banking System
Assets
Liabilities
Reserves
Checkable Deposits
Liabilities
Reserves
(or notes)
What happens to total reserves, monetary base?
What happens if the non-bank public converts the check into
currency and prefers holding cash?
10
III. Multiple Deposit Creation:
We now show that an open market purchase of $100 creates
_____________. Thus although MB goes up by $100, M1
______________
First National Bank (initial position after open market purchase)
Assets
Liabilities
Securities
Reserves
Assets
First National Bank (final position)
Liabilities
Securities
Loans
11
Multiple Deposit Creation: Banking System
Assets
Reserves
Assets
Reserves
Loans
Assets
Reserves
Assets
Reserves
Loans
Bank A (initial position)
Liabilities
Deposits
Bank A (final position)
Liabilities
Deposits
Bank B (initial position)
Liabilities
Deposits
Bank B (final position)
Liabilities
Deposits
12
Total new checkable deposits created by banks A - … as a result of a $100
increase in the monetary base is
In symbols, if ΔR = initial increase in reserves, r = required reserve ratio,
then total increase in checkable deposits by the banking system as a whole
is,
1/r is defined as the _______________.
The amount of new deposits created is less than _______ if,
1.people prefer _________________
2.banks prefer __________________
13
For the interested student who wants to
know more about the monetary tools
used by the FED, not important for the
final
14
Monetary policy tools – open market operations and how it influences the
federal funds rate
Federal funds rate
Federal funds rate
s0
S1
supply of
overnight reserves
demand for
overnight reserves
quantity of reserves
demand and supply of federal
funds, before an open market
operations
demand
for
overnight
reserves
quantity of reserves
demand and supply of federal
funds, after an open market
operations
15
Monetary policy tools – changes in the discount rate and how it influences
the federal funds rate
Federal funds rate
Federal funds rate
s0
supply of
overnight reserves
S1
demand for
overnight reserves
quantity of reserves
demand and supply of federal
funds, before a change in the
discount rate
demand
for
overnight
reserves
quantity of reserves
demand and supply of federal
funds, after a change in the
discount rate
16