III. Types of
Monetary Controls
A. Quantitative affect the money supply.
1. Required Reserve Ratio
a. Lowering the reserve ratio creates excess reserves
which banks may loan
as newly created money. This is expansionary.
b. Raising the reserve ratio eliminates excess reserve so banks
can not renew
loans removing money and causing
a contraction.
2.
Open-market operations
a. Buying and selling of U.S. government bonds by the Federal
Reserve from banks
or in the open market to change
excess reserves thus affecting the supply of M1
and interest rates is
the primary tool.
b. Buying bonds is expansionary.
1) When buying from banks, the Federal Reserve pays with
reserves providing
excess reserves banks can loan as
demand deposits.
2) When buying in the open market, increased demand from the
Federal Reserve
pushes up prices sellers receive, lowering the effective interest sellers pay.
c. Selling bonds contracts the economy.
d. Review of
Valuing bonds
1) Suppose you buy a twenty year, $10,000 bond paying 5% per year at
face value
of $10,000. Face value is called par value.
a) A few years go by and you need money and one choice is to sell the
bond.
b) If interest rates on this type bond have gone down, people will be
very anxious
to buy, demand, will be
high pushing price up and your will receive more than
$10,000.
c) If rate shave gone down, no one will give you $10,000, demand will be
low,
so if you need the money, you will sell for less, below par.
d) You can hold for twenty years and get par and get the money some
where else.
2) Therefore, interest rates and bond values (prices) go in the opposite
direction,
if interest rates down, old bond price up
because they are at the old higher rate.
3) This is called the interest rate risk for bonds. Other risks have to
do with issuer
default and monetary inflation.
e.
Federal
Open Market Committee minutes make interesting reading.
f. It is the most powerful of the four tools.
g. Historical Note on lender of last resort type actions before there was
a central
bank began in response to the Panic of 1837 (U.S. first great
depression.
source
1. "The Secretary of the Treasury,
Salmon P.
Chase, bought $13.5 million in
National 5-20 bonds, but this tepid
government response did little
to calm the markets (Juglar 95)." Tepid response would be used to
describe
FED actions during Great Recession.
2. "The New York Clearing House had two tools at its disposal for combating
banking panics and liquidity crises, in the form of loan certificates and
reserve pooling."
3. Discount rate
a. This is the rate charged by the Federal Reserve for loans to member banks.
b. It strongly affects the prime
interest rate paid by a bank's best customers.
1) Lower the rate to expand economy as interest rates decrease.
2) Raise the rate to contract economy as interest rates increase.
3) Another important interest rate is the federal
funds rate which is the rate at which
banks loan funds to each other.
4.
Term Auction
Facility
a. Initiated in 2007, it allows banks to add to their reserves at low rates.
b Done to increase bank liquidity which was low because of a loss in reserve
caused by a housing crisis.
B. Qualitative controls affect the actions of market participants.
1. Moral suasion or jawboning
a. This social pressure by influential
people to encourage specific people to act in the
public interest.
b. It is used to influence public opinion and political attitudes.
c. An example is when the Chairman of Board of Governors makes his
Semiannual
Report to Congress on the economy and
monetary policy.
2.
Margin Requirements, the down payment required on stocks which is now
50%,
is seldom changed.
3.
Consumer Credit Controls, on items such as credit cards, work so well it
is seldom used.
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