Tài chính doanh nghiệp - Chapter 13: The tools and goals of central bank monetary policy

Chapter 13The Tools and Goals of Central Bank Monetary Policy Learning Objectives To understand how the policy tools available to central banks work in carrying out a nation’s money and credit policies.To explore the strengths and weaknesses of the various monetary policy tools.To learn how the Federal Reserve System controls U.S. credit and interest rate levels.To see how central bank policy actions affect a nation’s economic goals.IntroductionCentral banks are given the task of regulating the money and credit system in order to achieve the economic goals of maximum employment, a stable price level, and sustainable economic growth.Although these objectives are not easy to achieve and often conflict, the central bank has powerful policy tools at its disposal.General versus Selective Credit ControlsGeneral credit controls affect the entire banking and financial system.Examples: reserve requirements, the discount rate, open market operationsSelective credit controls affect specific groups or sectors of the financial system.Examples: moral suasion, margin requirements on the purchase of listed securitiesReserve RequirementsIn the U.S., all depository financial institutions (including nonmembers) are required to conform to the deposit reserve requirements set by the Fed.Changes in reserve requirements are a very potent, though little-used tool.Indeed, reserve requirements have recently been reduced in the U.S., and eliminated in Canada, New Zealand, and the U.K.Reserve RequirementsAn increase in deposit reserve requirementsdecreases the deposit and money multipliers, slowing the growth of money, deposits and loansreduces the amount of excess legal reserves - institutions deficient in required legal reserves will have to sell securities, cut back on loans, or borrow reservesincreases interest rates, particularly in the money market, as depository institutions scramble to cover any reserve deficienciesEffects of Changes in Reserve Requirements on Deposits, Loans, and InvestmentsEffects of Changes in Reserve Requirements on Deposits, Loans, and InvestmentsCurrent Levels of Reserve RequirementsThe Discount RateThe discount rate is the interest rate that the Federal Reserve banks (and many other central banks as well) charge on loans they grant to other institutions (principally banks and security dealers).For the most part, these loans are regarded as temporary credit and a backup source of funds to the money market, where credit is usually much cheaper and easier to find.The Discount RateIn 2003, the Federal Reserve redesigned the discount windows:Primary credit is extended only to sound depository institutionsSecondary credit is intended for borrowing institutions that do not qualify for primary credit. This money cannot be used for asset expansion.Seasonal credit is usually available only to relatively small depositories that show a clear pattern of seasonal (intrayear) fluctuations in their deposits and loans.The Discount RateAnother recent significant change made by the Fed involved setting the discount rate on primary and secondary credit above the target interest rate on federal funds.This new discount-window policy ensures a “no hassle” supply of primary credit to sound depository institutions facing emergencies.The primary credit rate is also expected to serve as a cap for the prevailing market rate on federal funds.The Discount RateDiscount Window Loans Granted, May 2004 (in millions of dollars)The Discount RateThe Discount RateAn increase in the discount ratereduces the volume of loans from the discount window (cost effect)makes borrowing from the Fed less attractive (substitution effect)signals that the Fed is pushing for tighter credit conditions (announcement effect), and market participants may respond by curtailing their spending plans or by accelerating their borrowings (to secure the credit they need before interest rates move even higher)The Discount RateBeginning in 1999, the Fed’s discount rate was set up to follow the federal funds interest rate.In 2003, the spread was set at 1 percentage point (100 basis points). so as to turn the discount rate and the discount window into a relatively passive tool in the conduct of U.S. monetary policy.Open Market OperationsOpen market operations in the U.S. consist of the buying and selling of U.S. government and other securities by the Federal Reserve System to affect the quantity and growth of legal reserves, and ultimately, general credit conditions.Open market operations are a most flexible policy tool, suitable for fine-tuning the financial markets.Open Market OperationsThe open market tool has two major effects.When the Fed is purchasing securities, the additional demand for the securities in the market tends to increase their prices and lower their yields, so interest rates decline.A Federal Reserve purchase of government securities increases the reserves of the banking system and expands its ability to make loans and create deposits, thereby increasing the growth of money and credit.Open Market OperationsOpen Market OperationsOpen Market OperationsAll trading in securities by the Federal Reserve System is carried out through the System’s Trading Desk, located at the Federal Reserve Bank of New York.The Desk is supervised by the manager of the System Open Market Account (SOMA).The manager is guided by policy directives from Federal Open Market Committee (FOMC) meetings and checked through conference calls.Open Market OperationsFederal Open Market Committee StatementTypes of Federal Reserve Open Market TransactionsOutright or Straight Open Market Transaction(permanent change in the level of reserves held by depository institutions)FederalReservebankFed buys securitiesDealerDealer’s bankSecuritiesReservesFederalReservebankFed sells securitiesDealerDealer’s bankSecuritiesReservesTypes of Federal Reserve Open Market TransactionsRP or Reverse RP Transaction(temporary change in the level of reserves held by depository institutions)RP: Fed buys securities temporarilyFederalReservebankDealerDealer’s bankSecuritiesReservesLater on:ReservesSecurities returnedReverse RP: Fed sells securities temporarilyFederalReservebankDealerDealer’s bankSecuritiesReservesLater on:ReservesSecurities returnedTypes of Federal Reserve Open Market TransactionsRun-Off Transaction(permanent reduction in the level of reserves held by depository institutions)FederalReservebankSells more securities to raise more cashPays cashTreasuryMaturing Treasury securitiesDealerDealer’sbankOrders bank to pay for the new securitiesReservesTypes of Federal Reserve Open Market TransactionsAgency Transaction (Type A)(no change in the total level of reserves held by all depository institutions)FederalReservecustomerPlaces order for securities through a Federal Reserve bank which then contacts dealerDelivers securitiesDealerDealer’sbankOrders payment to dealerReservesCustomer’sbankTypes of Federal Reserve Open Market TransactionsAgency Transaction (Type B)(permanent reduction in the level of reserves held by depository institutions)FederalReservecustomerPlaces order for securitiesSecurities delivered from Fed’s own portfolioFederalReservebankOrders payment to FedReservesCustomer’sbankOpen Market OperationsDefensive open market operations are technical adjustments in market conditions to preserve the status quo and to maintain the present pattern of interest rates and credit availability.In contrast, dynamic open market operations are designed to upset the status quo and to change interest rates and credit conditions to a level the Fed believes to be more consistent with its economic goals.Selective Credit Controls Used by the FedMoral suasion refers to the use of “arm-twisting” or “jawboning” by central bank officials to encourage lending institutions and the public to conform with the spirit of its policies.Selective Credit Controls Used by the FedMargin requirements on the purchase of stocks and convertible bonds and on short sales of securities limit the amount of credit that can be used as collateral for a loan.Since 1974, the U.S. margin requirement on stocks, convertible bonds, and short sales has been 50% of the market value of the securities.Selective Credit Controls Used by the FedInterest Rate TargetingIn recent years, the Federal Reserve has given increasing weight to targeting the cost and availability of credit in the money market.The money market indicator that usually feels the first impact from Federal Reserve policy moves is the effective federal funds rate or daily average interest rate on federal funds transactions.Beginning in 1989 the Fed adopted a federal funds interest rate targeting procedure.Interest Rate TargetingBorrowed reserves are loans made to depository institutions by the Federal Reserve banks. Nonborrowed reserves are legal reserves that belong to depository institutions.The Fed achieves its target through open market operations that impact primarily the nonborrowed reserves (and hence the total reserves) available to the banking system.Interest Rate TargetingD’When the demand for reserves S’The Fed supplies more reservesSuch that the federal funds rate is maintained at the desired levelE’Federal Funds Interest Rate (%)Supply of Reserves ($)DSEInterest Rate TargetingInterest Rate TargetingNote that long-term capital market interest rates may not respond in the same way as short-term federal funds rate to the Fed’s activities in the financial marketplace.For example, higher inflationary expectations may push long-term interest rates upward as capital market investors seek compensation for the fear of greater inflation.The Federal Reserve and Economic GoalsThe Goal of Controlling Inflation (& Deflation)Inflation creates undesirable distortions in the allocation of scarce resources.In the 1990s, several central banks (such as New Zealand, Canada, and U.K.) began setting target inflation rates or rate ranges.The U.S. has not set an explicit target, though it seeks to drive inflation so low that it does not affect business and consumer decisions.The Federal Reserve and Economic Goals13 - 39The Federal Reserve and Economic GoalsThe Goal of Maximum EmploymentThe Employment Act of 1946 committed the U.S. government to maximizing employment as a major national goal.The Federal Reserve and Economic GoalsThe Federal Reserve and Economic GoalsThe Goal of Sustainable Economic GrowthThe Federal Reserve has declared that one of its most important long-term goals is to keep the economy growing at a relatively steady and stable rate – that is, a rate high enough to absorb increases in the labor force and prevent the unemployment rate from rising but slow enough to avoid runaway inflation.The Federal Reserve and Economic GoalsRates of Growth in Real U.S. GNP & GDP(Compounded Annual Rates of Change)The Trade-offs Among Central Bank GoalsNot every nation makes it clear to its central bank what its priorities should be among different possible goals.The goals may also conflict with one another.For example, controlling inflation may require the central bank to slow down the domestic economy through restrictions on credit growth and higher market interest rates.However, this policy threatens to generate more unemployment and subdue economic growth.The Trade-offs Among Economic GoalsHowever, there is growing research evidence that maximum employment, sustainable economic growth, and price stability can be compatible with one another in the longer run.The Limitations of Monetary PolicyCentral banks cannot completely control financial conditions or the money supply.Changes in the economy feed back on the money supply and the financial markets.The structure of the economy is changing due to deregulation, internationalization, technological developments, etc., such that changes in domestic interest rates may not be as potent a factor affecting the economy as they were a decade ago.Markets on the NetThe Federal Reserve System at www.federalreserve.govBank of Canada at www.bankofcanada.ca/enBank of England at www.bankofengland.co.uk/ Bank of Japan at www.boj.or.jpEuropean Central Bank www.ecb.intFederal Open Market Committee at www.federalreserve.gov/fomcMarkets on the NetInterest-Rate Targeting at www.federalreserve.gov/fomcReserve Bank of New Zealand at www.rbnz.govt.nzThe Discount Window at www.frbdiscountwindow.orgChapter ReviewIntroduction to the Tools and Goals of Monetary PolicyGeneral versus Selective Credit ControlsGeneral Credit Controls of the FedReserve RequirementsThe Federal Reserve’s Discount RateOpen Market OperationsChapter ReviewSelective Credit Controls Used by the FedMoral Suasion by Central Bank OfficialsMargin Requirements Interest Rate TargetingThe Federal Funds RateFed Funds Targeting and Long-Term Interest RatesChapter ReviewThe Federal Reserve and Economic GoalsThe Goal of Controlling InflationThe Goal of Maximum EmploymentThe Goal of Sustainable Economic GrowthThe Trade-offs Among Central Bank GoalsThe Limitations of Monetary Policy