Tài chính doanh nghiệp - Chapter 4: Functions of the fed

Chapter 4Functions of the FedFinancial Markets and Institutions, 7e, Jeff MaduraCopyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.1Chapter OutlineOrganization of the FedMonetary policy toolsImpact of technical factors on fundsFed control of the money supplyMonetary Control Act of 1980Global monetary policy2Organization of the FedThe Fed has five major components:Federal Reserve district banksMember banksBoard of GovernorsFederal Open Market Committee (FOMC)Advisory committees3Organization of the Fed (cont’d)Federal Reserve district banksThere are 12 Federal Reserve district banksThe NY bank is the most importantCommercial banks that become members of the Fed must purchase stock in their district banksPays a maximum dividend of 6% annuallyEach district bank has nine directorsSix elected by member banks; three appointed by the Board of GovernorsThe nine directors appoint the president of the district bankDistrict banks clear checks, replace old currency, provide loans to depository institutions, and conduct research4Organization of the Fed (cont’d)Member banksAll national banks are required to be members of the FedState-chartered banks are not required to be membersAbout 35% of all banks are members5Organization of the Fed (cont’d)Board of GovernorsThe Board of Governors consists of seven membersEach member is appointed by the President of the U.S. and confirmed by the SenateMembers serve 14-year termsReduces political pressureTerms are staggered so that one term expires in every even-numbered yearMain roles:Regulate commercial banksControl monetary policy6Organization of the Fed (cont’d)Federal Open Market Committee (FOMC)The FOMC consists of the seven members of the Board of Governors plus the presidents of five Fed district banksNY plus four others on a rotating basisGoals: promote high employment, economic growth, and price stabilityAchieved through control of the money supplyDecisions on changes in monetary policy are forwarded to the Trading Desk (Open Market Desk) at the NY Fed district bank7Organization of the Fed (cont’d)Advisory committeesThe Federal Advisory Council consists of one member from each district Makes recommendations to the Fed about economic and banking issuesThe Consumer Advisory Council consists of up to 30 membersRepresents the financial institutions industry and its consumersThe Thrift Institutions Advisory Council consists of representatives of savings banks, S&Ls, and credit unionsOffers views on issues specifically related to thrift institutions8Integration of Federal Reserve ComponentsAdvisory CommitteeBoard of GovernorsRegulates member banks and BHCsSets reserve requirementsSupervisionFederal OpenMarket CommitteeConducts openmarket operationsFederal Reserve District BanksClear checksReplace old currencyProvide loans to depository institutions9Monetary Policy ToolsOpen market operationsThe FOMC meets 8 times a yearAt each meeting, the target money supply growth level and interest rate level are determinedFOMC meeting agendaMembers receive the Beige Book two weeks prior to the meetingMeeting is attended by the Board of Governors, the 12 presidents of the district banks, and staff membersStaff members begin with presentations about current economic conditions and recent economic trendsNext, each FOMC member can offer recommendations about whether monetary growth and interest rate target levels should be changedLast, voting members vote on monetary policy and interest rates10Monetary Policy Tools (cont’d)Open market operations (cont’d)Communication to the Trading DeskThe FOMC’s decision on target money supply levels is forwarded to the Trading Desk at the NY district bank through a policy directiveFOMC objectives are specified in a target range for the money supply growthThe FOMC also specifies a desired target for the federal funds rateThe federal funds rate is the rate charged by banks on short-term loans to each other11Monetary Policy Tools (cont’d)Open market operations (cont’d)Role of the Trading DeskThe manager of the Trading Desk instructs traders on the amount of government securities to buy or sell in the secondary marketThis is called open market operationsThe Trading Desk continuously conducts open market operations in response to ongoing changes in bank deposit levels12Monetary Policy Tools (cont’d)Open market operations (cont’d)Fed purchase of securitiesTraders at the Trading Desk call government securities dealers to purchase securitiesDealers provide a list of securities for saleTraders purchase those that are most attractiveThe total funds of commercial banks increase by the dollar amount of securities purchased by the FedA loosening of the money supplyTo force a decline in the Fed funds rate, the Trading Desk can also purchase Treasury securitiesThe Fed funds rate will decline along with other interest rates13Monetary Policy Tools (cont’d)Open market operations (cont’d)Fed sale of securitiesTo decrease the money supply, traders sell government securities to government securities dealersSold to the dealer submitting the highest bidAs dealers pay, their account balances are reduced and the total amount of funds at commercial banks is reducedA tightening of the money supplyTo force an increase in the Fed funds rate, the Trading Desk can also sell Treasury securities14Monetary Policy Tools (cont’d)Open market operations (cont’d)Fed use of repurchase agreementsUsed to increase the aggregate level of bank funds for only a few daysThe Trading Desk trades repurchase agreements rather than government securitiesPurchases Treasury securities with an agreement to sell back the securities at a specified date in the near futureOften used during holidays to correct temporary imbalances15Monetary Policy Tools (cont’d)Open market operations (cont’d)How open market operations affect interest ratesWhen the Fed uses open market operations to increase bank funds, interest rates are affected because:The fed funds rate may declineBanks with excess funds may offer new loans at a lower interest rateBanks may lower interest rates on depositsThe yield on Treasury securities may decline16Monetary Policy Tools (cont’d)Open market operations (cont’d)How open market operations affect interest rates (cont’d)As yields on bank deposits and Treasuries decline, investors look for alternative securitiesThe yields on the alternative investments will decline as more money is invested in themThe reduction in yields on debt securities lowers the cost of borrowing for the issuers of debt securitiesCan encourage potential expenditures17Monetary Policy Tools (cont’d)Open market operations (cont’d)Dynamic vs. defensive open market operationsDynamic operations are implemented to increase or decrease the level of fundsDefensive operations offset the impact of other conditions that affect the level of funds18Monetary Policy Tools (cont’d)Open market operations (cont’d)Open market operations in response to the CrashStock prices declined by 22 percent on October 19, 1987The Fed loosened the money supply to provide liquidityThe Fed monitored bank deposits to ensure there was no run on depositsThe Fed monitored credit relationships between commercial banks and securities firmsOpen market operations in response to the weak economy in 2001The Fed increased money supply growth to stimulate the economyBusinesses did not respond to lower interest rates19Monetary Policy Tools (cont’d)Open market operations (cont’d)Open market operations in response to the September 11 attack on the United StatesThe FOMC decided to add liquidity to the banking system to prevent a banking crisisThe FOMC left the federal funds rate target unchangedOn September 17, the FOMC reduced the federal funds target rate by 50 basis points just before markets reopened20Monetary Policy Tools (cont’d)Adjusting the discount rateTo increase the money supply, the Fed can authorize a reduction in the discount rateEncourages depository institutions to borrow from the FedTo decrease the money supply, the Fed can increase the discount rateDiscouraged borrowing from the Fed21Monetary Policy Tools (cont’d)Adjusting the discount rate (cont’d)In January 2003 the Fed classified its loans as primary or secondary creditPrimary credit can be used for any purpose but it available only to financially sound institutionsSecondary credit is provided to banks that do not qualify for secondary creditContains a risk premium above the discount rate22Monetary Policy Tools (cont’d)Adjusting the discount rate (cont’d)Recently, the Fed has often adjusted the discount rate to keep it in line with changes in the targeted federal funds rateIn January 2003, the Fed set the discount rate at a level above the federal funds rateLoans from the Fed serve as a backup source of fundsThe discount rate no longer serves as a signal about the Fed’s monetary policy23Monetary Policy Tools (cont’d)Adjusting the reserve requirement ratioThe reserve requirement ratio is the proportion of bank deposits that must be held as reservesSet by the Board of GovernorsHistorically set between 8 and 12 percentCurrently 10 percent of transaction accountsSometimes changed to adjust the money supplyA reduction increases the proportion of bank deposits that can be lent out24Monetary Policy Tools (cont’d)Adjusting the reserve requirement ratio (cont’d)How reserve requirement adjustments affect money growthAn initial increase in demand deposits as a result of loosening the money supply multiplies into (1/reserve requirement ratio)A higher ratio causes an initial injection to multiply by a smaller amount25Monetary Policy Tools (cont’d)Comparison of monetary policy toolsThe most frequent monetary policy tool is open market operationsOpen market operations can be used without signaling the Fed’s intentions and can be easily reversedAdjustments in the discount rate only work if depository institutions respond to the adjustmentAdjustments in the reserve requirement ratio can cause erratic shifts in the money supply26Impact of Technical Factors on FundsThe volume of funds can change without the Fed’s intervention because of:Federal Reserve floatThe amount of checks credited to banks’ funds that have not yet been collectedCurrency in circulationStaff at the NY Fed and the Board of Governors provide daily forecasts of how technical factors will affect the level of funds27Fed Control of the Money SupplyThe Fed must decide what form of money to manipulateThe optimal form of money should:Be controllable by the FedHave a predictable impact on economic variables28Fed Control of the Money Supply (cont’d)M1 includes currency held by the public and checking depositsM1 is the most narrow form of moneyM2 includes everything in M1 plus savings accounts and small time deposits, money market deposit accounts (MMDAs), and other itemsM3 includes everything in M2 plus large time deposits and other items29Fed Control of the Money Supply (cont’d)Limitations of controlling money supplyIt may be difficult for the Fed to simultaneously control money supply growth and the federal funds rateIn October 1979 it focused primarily on the money supplyIn the last several years, the Fed focused on maintaining the federal funds rate within a narrow target rangeIn 2000, the Fed reduced its focus on the use of specific money supply target rangesM2 remains in the Index of Leading Economic Indicators30Monetary Control Act of 1980The Depository Institutions Deregulations and Monetary Control Act (DIDMCA) of 1980 had two objectives:To deregulate some aspects of the depository institutions industryTo enhance the Fed’s ability to control the money supply31Monetary Control Act of 1980 (cont’d)DIDMCA mandates that all depository institutions be subject to the same reserve requirements imposed by the FedApplies to member and nonmember banksAll depository institutions must report their deposit levels promptly to the FedImproves the Fed’s knowledge of the current level of deposits in the banking systemDIDMCA allowed all depository institutions that offer transaction accounts to have access to the discount window32Global Monetary PolicyCentral banks of other countries use open market operations, reserve requirement adjustment, and adjustments in the interest rate they charge on loansThe Fed must consider economic conditions in other major countries when assessing the U.S. economyCoordinating monetary policy may be difficult because of conflicts of interest33Global Monetary Policy (cont’d)A single Euro zone monetary policyOn June 1, 2002, the euro replaced the currencies of 12 European countriesThe European Central Bank (ECB) sets monetary policy for all participating countriesObjective is to control inflation and to stabilize the value of the euroImpact of the euro on monetary policyThe interest rate offered on government securities must be similar across participating countriesThe euro prevents any single country from using a unique monetary policy34Global Monetary Policy (cont’d)Global central bank coordinationSometimes central banks of various countries coordinate efforts for a common causeAfter September 11, 2001, central banks of various countries injected money into the banking system to provide more liquidityOn September 17, 2001, several central banks reduced their interest ratesSometimes central banks have conflicting objectivesIf two countries attempt to weaken their currencies simultaneously, the exchange rate is subject to conflicting forces35