Econ 3229 Ch 18

The tools of monetary policy available to the Fed include the discount rate, target federal funds rate, and reserve requirement. The currency to deposit ratio is not a tool of monetary policy used by the Fed.

If the demand for reserves decreases while the current market federal funds rate equals the target rate, there will be an excess supply of reserves in the market. This excess supply will push down the price of reserves, which is the federal funds rate. Therefore, the likely response in the federal funds market will be a decrease in the market federal funds rate.

The correct answer is an increase in the size of the Fed's balance sheet through purchasing securities. This is because when the Fed purchases securities, it pays for them by creating new reserves and depositing them into the banking system. This increases the amount of reserves available to banks, which in turn increases their ability to lend and stimulate economic activity. Increasing the discount rate and making loans to non-bank corporations are not methods of injecting reserves into the banking system. Selling securities would actually decrease the size of the Fed's balance sheet and reduce reserves in the banking system.

Central banks today primarily focus on interest rates. This is because central banks use interest rates as a tool to control and influence the economy. By adjusting interest rates, central banks can stimulate or slow down economic activity, control inflation, and stabilize financial markets. Interest rates also play a crucial role in determining borrowing costs, investment decisions, and consumer spending, making them a key area of focus for central banks.

The Federal Reserve provides various types of loans, including primary credit, seasonal credit, and secondary credit. However, conditional credit is not one of the types of loans offered by the Fed.

Secondary credit provided by the Fed is designed for banks that are in trouble and cannot obtain a loan from anyone else. This type of credit is intended to provide temporary liquidity support to banks that are experiencing financial difficulties and are unable to secure funds from other sources. It serves as a last resort option for banks that are struggling and need assistance to meet their short-term funding needs.

Discount lending ties into the Fed's function of being the lender of last resort. This means that when commercial banks are unable to obtain funds from other sources, they can borrow directly from the Federal Reserve at a discount rate. This helps to ensure the stability and liquidity of the banking system, as the Fed acts as a backstop during times of financial stress. By providing this discount lending facility, the Fed can prevent widespread bank failures and maintain confidence in the banking system.

During a crisis, the Fed will only provide a discount loan to a bank if the bank is financially stable and can offer collateral for the loan. This ensures that the bank has the ability to repay the loan and reduces the risk for the Fed. If the bank does not have collateral, the interest rate on the loan will be higher, further incentivizing the bank to meet the necessary requirements. The Fed will not provide a discount loan if the bank would not fail without it, as this would not be a justified use of emergency funding.

Intermediate targets of monetary policy refer to instruments that are not directly controlled by central banks but are situated between operational instruments and objectives. These targets help central banks in achieving their ultimate goals by influencing economic variables such as interest rates, money supply, or exchange rates. By adjusting these intermediate targets, central banks can indirectly affect the overall economy and achieve their desired macroeconomic objectives.

Seasonal credit provided by the Fed is not as common as it used to be because other sources for long-term loans have developed for banks in seasonal areas. This means that banks in seasonal areas now have alternative options for obtaining long-term loans, reducing their reliance on seasonal credit from the Fed. As a result, the demand for seasonal credit has decreased, leading to its decline in popularity.

A good monetary policy instrument should be tightly linked to monetary policy objectives. This means that the instrument should directly influence or have a strong impact on achieving the desired goals of the monetary policy. By being closely aligned with the objectives, the instrument can effectively and efficiently be used to implement and adjust the monetary policy measures. It allows policymakers to have a clear understanding of how the instrument will affect the economy and helps in making informed decisions. This characteristic ensures that the monetary policy instrument is effective in achieving the desired outcomes of the policy.

Lending to nonbanks would be categorized as an unconventional monetary policy tool because it involves providing loans to institutions that are not traditional banks. This is different from the more common practice of lending to banks through the discount window or setting interest rates such as the federal funds rate target. Lending to nonbanks may be used as a tool to stimulate economic activity and provide liquidity to nonbank financial institutions during times of financial stress.

Central bankers have mostly abandoned intermediate targets over the last few decades. This means that they have shifted their focus away from using intermediate targets as a tool for monetary policy. Instead, they have adopted other strategies and approaches to achieve their policy goals. This shift could be due to various reasons such as changes in economic conditions, advancements in monetary policy frameworks, or a reassessment of the effectiveness of intermediate targets. Overall, central bankers have moved away from relying heavily on intermediate targets in their decision-making process.

The FOMC (Federal Open Market Committee) is responsible for setting the target federal funds rate. This rate is the interest rate at which depository institutions lend reserve balances to other depository institutions overnight. The FOMC uses this tool to influence the overall money supply and interest rates in the economy. The discount rate, on the other hand, is the interest rate at which depository institutions can borrow directly from the Federal Reserve. While the FOMC does have some influence over the discount rate, it is not the primary policy tool used by the committee. The dealer's spread refers to the difference between the buying and selling price of a security and is unrelated to the FOMC's policy decisions.

The components of the formula for the Taylor rule include the target federal funds rate, current inflation rate, and inflation gap. The 30-year US treasury bond rate is not included in the formula for the Taylor rule. The Taylor rule is an economic theory that suggests how central banks should set interest rates based on inflation and output gaps. The 30-year US treasury bond rate is not directly related to this rule and is not considered in the formula.

The target federal funds rate can be calculated by substituting the given values into the formula.
Target federal funds rate = 2 + current inflation + 1/2(inflation gap) + 1/2(output gap)
= 2 + 5% + 1/2(5% - 2%) + 1/2(3%)
= 2 + 5% + 1/2(3%) + 1/2(3%)
= 2 + 5% + 1.5% + 1.5%
= 10.5%
Therefore, the target federal funds rate would be 10.5%.

Central banks provide discount loans at a rate above the target interest rate. This is because discount loans are a form of emergency lending that is meant to be used as a last resort when banks are unable to obtain funds from other sources. By setting the discount rate above the target interest rate, central banks discourage banks from relying too heavily on these loans and encourage them to seek funding from other banks or the interbank lending market first. This helps to maintain stability in the financial system and ensures that banks have a strong incentive to manage their own liquidity effectively.

The Fed is reluctant to change the required reserve rate because even small changes in the rate can have a significant impact on the money multiplier and the level of deposits. This means that even a slight adjustment in the required reserve rate can lead to a large change in the money supply, which can have unintended consequences for the economy. Additionally, there is a time lag between changing the required reserve rate and changes in the money supply, which further complicates the decision-making process for the Fed.

The correct answer is "The Fed currently sets both an interest rate and a quantity target for monetary policy." This statement is incorrect because the Fed currently only sets an interest rate target for monetary policy, not a quantity target.

The coefficients in front of the inflation gap and the output gap in the Taylor rule determine the weight given to each variable in the central bank's decision-making process. If both coefficients are 0.5, it means that the Fed is giving equal weight to the objectives of inflation and output. This suggests that the central bank considers both variables equally important in its policy decisions.

During the period from 1979 to 1982, the Federal Reserve focused on using bank reserves as a tool for implementing monetary policy. As a result of this strategy, one side effect was that interest rates increased significantly. This means that borrowing money became more expensive, which could have had various impacts on the economy. Higher interest rates can discourage borrowing and spending, leading to a slowdown in economic activity. Additionally, higher interest rates can also attract foreign investors seeking higher returns, potentially causing an appreciation in the value of the currency.

If the market federal funds rate were below the target rate, the response from the Fed would likely be to sell US treasury securities. By selling these securities, the Fed reduces the money supply in the market, which increases the federal funds rate. This action helps to bring the market federal funds rate closer to the target rate set by the Fed.

Attaining the target federal funds rate involves forecasting the demand for reserves, which is subject to error. This means that even though the Fed sets a target rate, it may not be able to achieve it due to inaccurate forecasts. The actual federal funds rate can deviate from the target rate as a result.