Chapter 3 - The fed and interest rates. This chapter presents the following content: Federal reserve control of the money supply, the fed's influence on interest rates, the treasury department and fiscal policy, goals of monetary policy, the fed and the economy, complications of monetary policy, anatomy of a financial crisis. | Power Point Slides for: Financial Institutions, Markets, and Money, 9th Edition Authors: Kidwell, Blackwell, Whidbee & Peterson Prepared by: Babu G. Baradwaj, Towson University And Lanny R. Martindale, Texas A&M University CHAPTER 3 THE FED AND INTEREST RATES The monetary base comprises the Fed’s 2 largest liabilities: Federal Reserve Notes in circulation Depository institution reserves (reserve account balances and vault cash) The money supply involves the Monetary Aggregates The Fed controls the monetary base . To meet reserve requirements, depository institutions must transact with Fed in monetary base assets. They either - deposit adequate reserves at FRB or maintain adequate cash in vault Either way, reserves - required or excess - earn no interest. The more cash or reserves an institution holds above its requirements with the Fed, the more it wants to make new loans or investments to avoid lost interest income. Thus the Fed controls the money supply . Excess . | Power Point Slides for: Financial Institutions, Markets, and Money, 9th Edition Authors: Kidwell, Blackwell, Whidbee & Peterson Prepared by: Babu G. Baradwaj, Towson University And Lanny R. Martindale, Texas A&M University CHAPTER 3 THE FED AND INTEREST RATES The monetary base comprises the Fed’s 2 largest liabilities: Federal Reserve Notes in circulation Depository institution reserves (reserve account balances and vault cash) The money supply involves the Monetary Aggregates The Fed controls the monetary base . To meet reserve requirements, depository institutions must transact with Fed in monetary base assets. They either - deposit adequate reserves at FRB or maintain adequate cash in vault Either way, reserves - required or excess - earn no interest. The more cash or reserves an institution holds above its requirements with the Fed, the more it wants to make new loans or investments to avoid lost interest income. Thus the Fed controls the money supply . Excess reserves appear as Fed - buys securities on open market, lends at Discount Window, or lowers reserve requirements and the Money Supply affects the economy. Proceeds of new loans or investments not only increase M1 but finance purchases by DSUs of goods or services in real sector, contributing to economic growth. By expanding or contracting monetary base, Fed - increases or decreases excess reserves, thus raising or lowering incentive to lend or invest, thus encouraging or discouraging expansion in real sector. To influence interest rates, Fed targets but does not set Fed Funds Rate Fed Funds market is Fed-sponsored system in which depository institutions lend and borrow excess reserves among themselves Fed Funds Rate, set by market forces as institutions bargain with each other, is benchmark rate, measuring As Fed adjusts tools of monetary policy, reserve effects influence Fed Funds rate significantly in short run Open Market Operations: Buying pressures FFR downward, selling
