Chapter 16: Monetary Policy Tools
1. The Federal Funds Market and Reserves
Central banks have three primary tools for influencing
the money supply
Discount
loans
Open
market
operations
Reserve
requirement
Money
supply
1. The Federal Funds Market and Reserves
The reserve requirement
works through the money multiplier,
constraining multiple deposit expansion
the larger it becomes.
Central banks today rarely use it because most banks work around
reserve requirements.
1. The Federal Funds Market and Reserves
Discount loans
influence the monetary base (MB = C + R).
Discount loans depend on
banks (or non-bank borrowers, where applicable)
first borrowing, then repaying loans.
The central bank does not have precise control over MB.
1. The Federal Funds Market and Reserves
Open market operations
influence the monetary base (MB = C + R).
Open market operations (OMO) are generally preferred.
The central bank can easily
expand or contract MB to a precise level.
Using OMO, central banks can also reverse mistakes quickly.
1. The Federal Funds Market and Reserves
The Fed Funds Market: banks that need reserves can borrow
them from banks that hold reserves they don’t need.
Fed Funds
Market
Overnight bank
borrowing
Lower rates
Higher rates
Directly from
Fed
More Fed
scrutiny
1. The Federal Funds Market and Reserves
If Fed Funds rate < discount rate,
banks borrow in Fed Funds Market
If Fed Funds rate > discount rate,
Arbitrage:
Borrow at discount window/Lend in Fed Funds Market
The discount rate sets an upper limit to ff* (the actual Fed Funds
rate) because no bank would borrow reserves at a higher rate
in the federal funds market than it could borrow directly from
the Fed.
2. Open Market Operations and the Discount Window
Open market activity decisions: Daily
FRBNY researches:
•
•
•
•
•
•
The level of reserves
The Fed Funds target
The actual market Fed Funds rate
Expectations regarding float
Treasury activities
Treasury market conditions
– primary dealers, specialized firms, and banks
2. Open Market Operations and the Discount Window
Open market activity decisions: Each day,
FRBNY determines buy or sell:
• Outright
– securities permanently join or leave Fed’s balance
sheet
• Repo (Repurchase agreement)
– purchase with a guarantee that seller will
repurchase
• Reverse repo (matched sale-purchase transaction)
– sell with guarantee that buyer will resell to Fed
2. Open Market Operations and the Discount Window
Discount window
is today primarily a backup facility used during crises
when the federal funds market might not function
effectively.
As lender of last resort, the Fed has a responsibility to
ensure that banks can obtain as much as they want
to borrow provided they can post what in normal
times would be considered good collateral security.
2. Open Market Operations and the Discount Window
Discount window
As lender of last resort, the Fed has a responsibility to ensure
that banks can obtain as much as they want to borrow
Provided they can maintain good collateral security
To ensure that banks do not rely too heavily on the
discount window:
• discount rate is usually set a full percentage point
above ff*, a “penalty” of 100 basis points
2. Open Market Operations and the Discount Window
Discount window: Crisis of 2008
Federal Reserve invoked its emergency powers to create additional lending
powers and programs, including:
• Term Auction Facility (TAF), a “credit facility” that allows depository
institutions to bid for short term funds at a rate established by auction
• Primary Dealer Credit Facility (PDCF), which provides overnight loans to
primary dealers at the discount rate
• Term Securities Lending Facility (TSLF) also helps primary dealers by
exchanging Treasuries for riskier collateral for 28-day periods
• Asset-Backed Commercial Paper Money Market Mutual Liquidity Facility,
which helps money market mutual funds to meet redemptions without
having to sell their assets into distressed markets
2. Open Market Operations and the Discount Window
Discount window: Crisis of 2008
Federal Reserve invoked its emergency powers to create additional lending
powers and programs, including:
• Commercial Paper Funding Facility (CPFF) allows the FRBNY, through a
special purpose vehicle (SPV), to purchase commercial paper (short term
bonds) issued by non-financial corporations
• Money Market Investor Funding Facility (MMIFF) is another lending
program designed to help the money markets (markets for short term
bonds) return to normal
2. Open Market Operations and the Discount Window
• The financial crisis also induced the Fed to engage in
several rounds of “quantitative easing” or Large Scale
Asset Purchases (LSAP)
– Goals:
1.
2.
increase the prices of (decrease the yields of) Treasury bonds
and the other financial assets purchased
influence the money supply directly.
• Due to LSAP, the Fed’s balance sheet swelled from
less than a trillion dollars in early 2008 to about 3
trillion in just a year
http://www.federalreserve.gov/monetarypolicy/bst_
recenttrends.htm
2. Open Market Operations and the Discount Window
The Discount window
is also used to provide
moderately shaky banks
a longer-term source of credit
at an even higher penalty rate
.5 percentage (50 basis) points
above the regular discount rate.
3. The Monetary Policy Tools of Other Central Banks
Federal Reserve
European Central Bank
• Uses Open Market
Operations (OMO) to
manage overnight interbank
rates
• Uses outright purchases,
repos, and reverse repos
• Lends at marginal lending
rates
• Pays interest on reserves
• Uses Open Market
Operations (OMO) to
manage overnight interbank
rates
• Uses outright purchases,
repos, and reverse repos
• Lends at marginal lending
rates
• Pays interest on reserves