ECO

 375  
Class  2  Notes  
 
Central  Banks  and  Monetary  Policy  
 
I. 1913  Federal  Reserve  Act  
a. Reserve  requirement  for  member  banks  
b. Created  12  districts  across  the  US  
c. Scope  of  responsibilities  
i. Monetary  policy  
1. Price  stability  (low  or  zero  inflation)  
2. Full  employment  
ii. Regulation  of  commercial  banks  
II. Current  major  components  of  Fed  
a. Federal  Reserve  District  Banks  (show  map)  
i. 12  districts  
 

 
 
 
ii. Commercial  banks  located  in  the  districts  that  become  
members  are  required  to  purchase  stock  in  the  district  bank  
1. This  gives  the  NY  district  bank  a  distinct,  more  powerful  
role  
 iii. Each  district  bank  in  governed  by  9  directors  
1. 6  elected  by  member  banks  
a. 3  are  professional  bankers  
b. 3  are  business  people  in  region  
2. 3  appointed  by  Board  of  Governors  
iv. Role  of  district  bank  
1. Support  banking  operations  
a. Clear  checks  
b. Replacing  currency  
c. Discount  window  operations  
2. Economic  data  and  research    
i. View  St.  Louis  Fed  website  
http://research.stlouisfed.org/fred2/  
b. Member  Banks  
i. All  national  banks  (required)  
ii. Some  State  chartered  banks  (not  required)  
iii. About  35%  or  banks,  but  70%  of  deposits  
c. Board  of  Governors  
i. 7  members,  each  appointed  by  the  POTUS  
ii. 14  year  terms  
iii. One  term  expires  every  2  years  (even  #  years)  
iv. One  member  is  selected  to  be  the  Chairman  
1. 4  year,  renewable  term  
2. Same  voting  power  
3. Elevated  influence  
v. Main  roles:  
1. Regulating  commercial  banks  
a. Oversees  district  banks  operations  with  member  
banks  
b. Margin  requirements  
2. Monetary  policy  
a. Revise  reserve  requirements  for  member  banks  
b. Participate  in  decisions  with  FOMC  
d. Federal  Open  Market  Committee  
i. Composition  (voting)  
1. Members  of  BOG  
2. Presidents  of  5  regional  banks  
a. NY  President  is  always  a  member  
b. 4  other  seats  rotate  among  the  banks  
3. 8  meetings  per  year  to  set  Fed  Funds  Rate  target  
4. Dissect  last  FOMC  report  
http://www.federalreserve.gov/newsevents/press/mo
netary/20100127a.htm  
ii. Mandate  
1. Unemployment  
2. Price  Stability  
 e. Advisory  Committees  
i. Federal  Advisory  Council  (4x  per  year)  
ii. Consumer  Advisory  Council  (4x  per  year)  
iii. Thrift  Institutions  Advisory  Council  (3x  per  year)  
III. Tools  of  the  Fed  
a. Open  market  operations-­‐  buying  and  selling  of  government  securities  
by  the  Fed  (dynamic  and  defensive)  
i. Impact  of  purchasing  securities  
ii. Impact  of  selling  securities  
iii. Repurchase  Agreements  
b. Reserve  Requirements  
i. 10%  since  1992  
ii. example  of  change  in  requirements  
c. Discount  rate  
i. Rate  that  banks  can  borrow  from  the  Fed  
IV. Mechanics  of  Monetary  policy  
a. Basics  
i. Impact  of  increase/decrease  of  supply  of  loanable  funds  on  
interest  rates  

ii. Relationship  between  interest  rates  and  investment  

 
 
 
 
 
 
 
 
 b. Transmission  channels  
i. Fed-­‐>investors-­‐>bank  funds-­‐>interest  rates-­‐>aggregate  
spending-­‐>economic  growth/inflation  
c. “Credit  crunch”  limitation  
i. Transmission  channels  can  break  down  (supplemental  
readings)  
d. Limitations  
i. Timing  problems  
1. Recognition  lag  
2. Implementation  lag  
ii. Rational  Expectations  
iii. Tradeoff  btw  employment  and  inflation  (Phillips  Curve)  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
V. The  intersection  of  Monetary  Policy  and  Fiscal  Policy  
i. Fiscal  policy  also  impacts  interest  rates  
1. Income  taxes-­‐>income-­‐>savings-­‐>supply  of  funds  
2. Budget  deficit-­‐>gov’t  demand  for  funds-­‐>US  demand  for  
funds-­‐>interest  rates  
3. Business  tax  rates-­‐>business  demand  for  funds-­‐>US  
demand  for  funds-­‐>interest  rates    
VI. Discussion  of  supplemental  readings  (role  of  Fed  in  2001-­‐2009  financial  
panic)  
a. “A  view  of  the  Economic  Crisis  and  the  Federal  Reserve’s  Response”  
i. Alternatives  measures  to  stimulate  the  economy  
1. Purchased  mortgage  securities  issued  by  Fannie  and  
Freddie  
 a. Pushed  mortgage  rates  to  near-­‐record  lows  (put  
this  in  the  context  of  supply-­‐demand  chart  from  
earlier)  
2. Purchased  large  quantities  of  long-­‐term  gov’t  debt  
a. Attempt  to  push  down  yields  and  therefore  the  
yields  of  debt  tied  to  Treasury  yields  
3. “Stress  tests”  of  banks  
4. Term  asset-­‐backed  securities  loan  facility  
b. “The  Federal  Reserve  Responds  to  Crisis:  September  11th  was  not  the  
First”  
i. Short  term  effect:  liquidity  
ii. Medium  term  effect:  output  gap  and  inflation  
iii. Long  term  effect:  consumption  and  production