Download Lecture 13: Monetary Policy

Lecture 14: Monetary Policy
Bank of England 1694
• Granted monopoly on joint stock banking
by Parliament in return for war loans.
• Not an invention of economists, started off
as a powerful bank that was able to demand
that other banks held deposits in it.
• Did not have government monopoly on note
issue, but achieved it through its monopoly
power.
Banks of the United States
• Loosely modeled after Bank of England
• First Bank of the United States 1791-1811,
was promoted by Alexander Hamilton
• Second Bank of the United States 18161836. President Andrew Jackson called it a
“dangerous monopoly,” conflict with
Nicholas Biddle, president.
• Suffolk System, Massachusetts
Nineteenth Century Problems and
Solutions
• Privately issued bank notes
• Discounts on notes
• Banking panics associated with business
depressions
• National Banking System, 1863, mostly ended
panics until 1907.
• 1907 panic saved by J. P. Morgan
• Under National Banking System inflexible money
supply, strongly seasonal interest rate
• Led to creation of Federal Reserve
Federal Reserve System - 1913
• Created flexible money supply, responding
to business situation
• Fed was lender of last resort
• 12 Regional banks, each presides over a
district.
• Two in Missouri
• Board of Governors in Washington DC
Board of Governors
• 7 members, 14-year terms
• Chairman has 4-year term. Traditional
power of the chairman
• Independent of executive and legislative
branch. An “independent central bank.”
• Chairman must make semiannual monetary
policy reports (Humphrey Hawkins)
Banking Panic of 1933
• Despite Fed’s lending, a banking panic
forced Roosevelt to declare a banking
holiday
• Led to establishment of Federal Deposit
Insurance Company (FDIC) opened doors
in 1934, funded by premia paid by banks
• No U. S. panics since
European Central Bank
• Founded 1998
• Eurozone members and non Eurozone
members
• Had to construct Eurozone data for first
time
• President Jean-Claude Trichet since 2003
• Otmar Issing
New Euro Currency
• Currency first issued
January 1, 2002
• “The parallel lines [in
€] “represent the
stability of the euro.”
Bank of Japan
• Toshihiko Fukui, Governor since 2003
• Interest rates have been brought down
virtually to zero
• Purchase of government bonds to try to
stimulate economy
• Proposals to buy foreign bonds, dollars
• Japanese banks sitting on unlent funds
Nikkei Index
Monthly 1984-I to 2004-II
45000
40000
35000
Nikkei Index
30000
25000
20000
15000
10000
5000
0
1980
1985
1990
1995
Year
2000
2005
2010
Monetary Problem in Japan
• Inflation often negative
• Gensaki rate zero
• Real rate often substantial, Bank of Japan
can do nothing
• Svensson proposal to peg yen at, say, 160 to
dollar, unheeded by conservative B of J
Reserve Requirements
• Depository Institutions Deregulation and
Monetary Control Act of 1980: 12% reserves on
demand deposits, 3% on time
• Act allows Fed to change reserve requirements, on
demand deposits within range 8% and 14%.
• Banks must meet requirements over two-week
statement period
• Reserves are in cash or balances with federal
reserve. Fedwire
FOMC
• Federal Reserve Board, President of New
York Fed, and four other reserve bank
presidents.
• Meets roughly once a month
• Since 1994, has made immediate
announcements of policy decision
• Since 1997 has made immediate
announcements of federal funds rate target
Trading Desk, FRBNY
• Buys and sells Treasury bills
• August 1999 FOMC gave desk
authorization to trade in mortgage-backed
securities
• FOMC is studying allowing desk to trade in
debt of states, or foreign countries.
Discount Rate and Federal Funds
Rate
• Discount rate is rate on loans Fed makes to
member banks.
• Borrowing is a privilege, not a right
• Federal funds rate is rate of interest banks
pay to each other when they lend excess
reserves.
• Repo rate is collateralized, hence tends to
be a little lower.
Changed Definition of
Discount Rate
• Prior to 2003, discount rate was usually 50 basis
points lower than the funds rate
• Then, borrowing at discount window carried
stigma
• On Jan 9, 2003, Fed raised discount rate above
funds rate, eliminating stigma
• Primary discount rate (sound banks) about 100
basis points above funds rate
• Secondary discount rate (banks that do not
qualify) 50 points above primary discount rate
Federal Funds Rate and Inflation
Rate Monthly 1954-VII to 2004-I
Real Federal Funds Rate Monthly
1954-VII to 2004-I
Stabilization and 1980 and 19812 Recessions
• New Fed Chairman Paul Volcker thought
inflation had gotten out of hand.
• Created “the great recession” that stopped
inflation
• Many foreign countries similar experience
Stabilization and 1990-1991
recession
• Fed was misled by inaccurate GDP
numbers, didn’t see recession coming.
• First started cutting interest rates Dec. 1990,
after recession had been on for six months
The 2001 Recession
• Not brought on by rising interest rates to
curb inflationary pressure
• A post-stock-market bubble recession
• Dramatic cuts in rates starting early 2001
• Recession short lived (March-November)
• Housing boom started by rate cuts