Conducting Monetary Policy at
Low Short Term Interest Rates
Eric Cramer
November 1, 2010Federal Reserve Challenge: Bank of...
Overview
November 1, 2010Federal Reserve Challenge: Bank of Chicago2
 Current State of the Economy
 Monetary Policy at L...
Overview
November 1, 2010Federal Reserve Challenge: Bank of Chicago3
 Current State of the Economy
 Monetary Policy at L...
Gross Domestic Product (Billions)
November 1, 2010Federal Reserve Challenge: Bank of Chicago4
Source: Congressional Budget...
Unemployment Index
November 1, 2010Federal Reserve Challenge: Bank of Chicago5
0.00
50.00
100.00
150.00
200.00
250.00
300....
Inflation
November 1, 2010Federal Reserve Challenge: Bank of Chicago6
Source: the Bureau of Labor Statistics and the Unive...
Overview
November 1, 2010Federal Reserve Challenge: Bank of Chicago7
 Current State of the Economy
 Monetary Policy at L...
Federal Funds Rate
November 1, 2010Federal Reserve Challenge: Bank of Chicago8
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7...
Monetary Policy at Low Interest Rates
November 1, 2010Federal Reserve Challenge: Bank of Chicago9
 Provide assurance to i...
Monetary Policy at Low Interest Rates
November 1, 2010Federal Reserve Challenge: Bank of Chicago10
 Provide assurance to ...
Spread Between BAA and 10yr T-Bond
November 1, 2010Federal Reserve Challenge: Bank of Chicago11
1.00%
2.00%
3.00%
4.00%
5....
Treasury Security Yield Curve
November 1, 2010Federal Reserve Challenge: Bank of Chicago12
Source: Board of Governors Fede...
Federal Reserve Balance Sheet
November 1, 2010Federal Reserve Challenge: Bank of Chicago13
As of October 21, 2010
Millions...
Balance Sheet Assets
November 1, 2010Federal Reserve Challenge: Bank of Chicago14
Source: Board of Governors Federal Reser...
Monetary Policy at Low Interest Rates
November 1, 2010Federal Reserve Challenge: Bank of Chicago15
 Provide assurance to ...
Overview
November 1, 2010Federal Reserve Challenge: Bank of Chicago16
 Current State of the Economy
 Monetary Policy at ...
Support for Quantitative Easing
November 1, 2010Federal Reserve Challenge: Bank of Chicago17
 Fed’s promise of Lower Inte...
Overview
November 1, 2010Federal Reserve Challenge: Bank of Chicago18
 Current State of the Economy
 Monetary Policy at ...
Inefficiencies of Quantitative Easing
November 1, 2010Federal Reserve Challenge: Bank of Chicago19
 Limited flexibility o...
Liquidity Trap
November 1, 2010Federal Reserve Challenge: Bank of Chicago20
 Further increases in
the money supply
will h...
Treasury Inflation Protected Securities
November 1, 2010Federal Reserve Challenge: Bank of Chicago21
-1.00%
0.00%
1.00%
2....
TED Spread
November 1, 2010Federal Reserve Challenge: Bank of Chicago22
-0.50%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3...
Current Credit Market Conditions
November 1, 2010Federal Reserve Challenge: Bank of Chicago23
-40.00%
-20.00%
0.00%
20.00%...
Capacity Utilization
November 1, 2010Federal Reserve Challenge: Bank of Chicago24
50.00%
55.00%
60.00%
65.00%
70.00%
75.00...
Overview
November 1, 2010Federal Reserve Challenge: Bank of Chicago25
 Current State of the Economy
 Monetary Policy at ...
Advantages of Quantitative Easing
November 1, 2010Federal Reserve Challenge: Bank of Chicago26
 Stabilize Output
 Cataly...
Housing Market Index
November 1, 2010Federal Reserve Challenge: Bank of Chicago27
Source: Board of Governors Federal Reser...
Overview
November 1, 2010Federal Reserve Challenge: Bank of Chicago28
 Current State of the Economy
 Monetary Policy at ...
Excess Reserves
November 1, 2010Federal Reserve Challenge: Bank of Chicago29
-2.00
-1.00
0.00
1.00
2.00
3.00
4.00
5.00
6.0...
Money Multiplier
November 1, 2010Federal Reserve Challenge: Bank of Chicago30
0.50
0.70
0.90
1.10
1.30
1.50
1.70
1.90
2.10...
Overview
November 1, 2010Federal Reserve Challenge: Bank of Chicago31
 Current State of the Economy
 Monetary Policy at ...
Conclusion
November 1, 2010Federal Reserve Challenge: Bank of Chicago32
 Implement the second round of quantitative easin...
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Fed Challenge Presentation

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This is the presentation that was given at the Federal Reserve Bank of Chicago for the 2010 Federal Reserve Challenge.

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Fed Challenge Presentation

  1. 1. Conducting Monetary Policy at Low Short Term Interest Rates Eric Cramer November 1, 2010Federal Reserve Challenge: Bank of Chicago1
  2. 2. Overview November 1, 2010Federal Reserve Challenge: Bank of Chicago2  Current State of the Economy  Monetary Policy at Low Interest Rates  Options Available  Federal Open Market Committee Recommendation  Quantitative Easing  Support  Inefficiencies  Advantages  Interest on Excess Reserves  Conclusion
  3. 3. Overview November 1, 2010Federal Reserve Challenge: Bank of Chicago3  Current State of the Economy  Monetary Policy at Low Interest Rates  Options Available  Federal Open Market Committee Recommendation  Quantitative Easing  Support  Inefficiencies  Advantages  Interest on Excess Reserves  Conclusion
  4. 4. Gross Domestic Product (Billions) November 1, 2010Federal Reserve Challenge: Bank of Chicago4 Source: Congressional Budget Office and the Bureau of Economic Analysis $8,000.00 $9,000.00 $10,000.00 $11,000.00 $12,000.00 $13,000.00 $14,000.00 $15,000.00 $16,000.00 Potential GDP Real GDP Forecasted GDP
  5. 5. Unemployment Index November 1, 2010Federal Reserve Challenge: Bank of Chicago5 0.00 50.00 100.00 150.00 200.00 250.00 300.00 350.00 400.00 450.00 500.00 January-00 January-01 January-02 January-03 January-04 January-05 January-06 January-07 January-08 January-09 January-10 Unemployment Rate Median Duration of Unemployment Source: the Bureau of Labor Statistics
  6. 6. Inflation November 1, 2010Federal Reserve Challenge: Bank of Chicago6 Source: the Bureau of Labor Statistics and the University of Michigan -3.00% -2.00% -1.00% 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% January-00 January-01 January-02 January-03 January-04 January-05 January-06 January-07 January-08 January-09 January-10 CPI Inflation Core CPI Inflation Expected Inflation
  7. 7. Overview November 1, 2010Federal Reserve Challenge: Bank of Chicago7  Current State of the Economy  Monetary Policy at Low Interest Rates  Options Available  Federal Open Market Committee Recommendation  Quantitative Easing  Support  Inefficiencies  Advantages  Interest on Excess Reserves  Conclusion
  8. 8. Federal Funds Rate November 1, 2010Federal Reserve Challenge: Bank of Chicago8 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% January-00 January-01 January-02 January-03 January-04 January-05 January-06 January-07 January-08 January-09 January-10 Federal Funds Rate Source: Board of Governors Federal Reserve
  9. 9. Monetary Policy at Low Interest Rates November 1, 2010Federal Reserve Challenge: Bank of Chicago9  Provide assurance to investors that short term rates will remain low in the future  Change the relative supplies of securities in the market by altering the composition of the Federal Reserve’s balance sheet  Increase the size of the Federal Reserve balance sheet
  10. 10. Monetary Policy at Low Interest Rates November 1, 2010Federal Reserve Challenge: Bank of Chicago10  Provide assurance to investors that short term rates will remain low in the future  Change the relative supply of securities in the market by altering the composition of the Federal Reserve’s balance sheet  Increase the size of the Federal Reserve balance sheet
  11. 11. Spread Between BAA and 10yr T-Bond November 1, 2010Federal Reserve Challenge: Bank of Chicago11 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% January-00 January-01 January-02 January-03 January-04 January-05 January-06 January-07 January-08 January-09 January-10 Spread Between 10Yr Treas and BAA Source: Board of Governors Federal Reserve
  12. 12. Treasury Security Yield Curve November 1, 2010Federal Reserve Challenge: Bank of Chicago12 Source: Board of Governors Federal Reserve 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 1 Month 3 Month 6 Month 1 Year 2 Year 3 Year 5 Year 7 Year 10 Year 20 Year 30 Year December 1, 2007 October 22, 2010
  13. 13. Federal Reserve Balance Sheet November 1, 2010Federal Reserve Challenge: Bank of Chicago13 As of October 21, 2010 Millions of Dollars Assets Liabilities Securities Deposits with Federal Reserve Banks $ 264,052 Held Outright $ 2,044,742 Reserve Balances $ 264,052 Treas. Sec and Fed Agency Debt $ 824,964 Other Liability and Capital $ 72,508 Mortgage Backed Securities $ 1,067,874 Other Loans $ 48,582 Monetary Base Primary Credit $ 32 Reserve Balances $ 983,202 Term Asset-Back Security $ 28,899 Currency $ 961,745 Maiden Lane LLC I, II, and III $ 66,465 Net Holdings of Commercial Paper -- Central Bank Liquidity Swaps $ 560 Other $ 98,475 Total Assets $ 2,343,438 Total Liabilities $ 2,251,827 Source: Board of Governors Federal Reserve
  14. 14. Balance Sheet Assets November 1, 2010Federal Reserve Challenge: Bank of Chicago14 Source: Board of Governors Federal Reserve 36% 7% 46% 12% USTreasury Securities Federal Agency Debt Securities Mortgage Backed Securities Other Assets
  15. 15. Monetary Policy at Low Interest Rates November 1, 2010Federal Reserve Challenge: Bank of Chicago15  Provide assurance to investors that short term rates will remain low in the future  Change the relative supply of securities in the market by altering the composition of the Federal Reserve’s balance sheet  Increase the size of the Federal Reserve balance sheet
  16. 16. Overview November 1, 2010Federal Reserve Challenge: Bank of Chicago16  Current State of the Economy  Monetary Policy at Low Interest Rates  Options Available  Federal Open Market Committee Recommendation  Quantitative Easing  Support  Inefficiencies  Advantages  Interest on Excess Reserves  Conclusion
  17. 17. Support for Quantitative Easing November 1, 2010Federal Reserve Challenge: Bank of Chicago17  Fed’s promise of Lower Interest Rates sounds more credible  Rebalancing of investment portfolios  Possible inflationary effects
  18. 18. Overview November 1, 2010Federal Reserve Challenge: Bank of Chicago18  Current State of the Economy  Monetary Policy at Low Interest Rates  Options Available  Federal Open Market Committee Recommendation  Quantitative Easing  Support  Inefficiencies  Advantages  Interest on Excess Reserves  Conclusion
  19. 19. Inefficiencies of Quantitative Easing November 1, 2010Federal Reserve Challenge: Bank of Chicago19  Limited flexibility on monetary policy when the economy recovers  Increased rates of inflation caused by excess reserves in the market  Increased inflation caused by an implementation lag from the previous use of quantitative easing  Obstacles of quantitative easing
  20. 20. Liquidity Trap November 1, 2010Federal Reserve Challenge: Bank of Chicago20  Further increases in the money supply will have little effect on interest rates.  There will be a limited increase in investment or GDP. InterestRate Quantity of Money Demand Supply2Supply1
  21. 21. Treasury Inflation Protected Securities November 1, 2010Federal Reserve Challenge: Bank of Chicago21 -1.00% 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% April-06 October-06 April-07 October-07 April-08 October-08 April-09 October-09 April-10 5-YearTIPS 10-YearTIPS Source: Haver Analytics
  22. 22. TED Spread November 1, 2010Federal Reserve Challenge: Bank of Chicago22 -0.50% 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% January-00 January-01 January-02 January-03 January-04 January-05 January-06 January-07 January-08 January-09 January-10 TED Spread Source: Board of Governors Federal Reserve and LIBORATED
  23. 23. Current Credit Market Conditions November 1, 2010Federal Reserve Challenge: Bank of Chicago23 -40.00% -20.00% 0.00% 20.00% 40.00% 60.00% 80.00% 100.00% January-00 January-01 January-02 January-03 January-04 January-05 January-06 January-07 January-08 January-09 January-10 Credit Cards Commercial Real Estate Small Firms Large and Medium Firms Source: Board of Governors Federal Reserve
  24. 24. Capacity Utilization November 1, 2010Federal Reserve Challenge: Bank of Chicago24 50.00% 55.00% 60.00% 65.00% 70.00% 75.00% 80.00% 85.00% January-00 January-01 January-02 January-03 January-04 January-05 January-06 January-07 January-08 January-09 January-10 Manufacturing Utilization Total Utilization Source: Board of Governors Federal Reserve
  25. 25. Overview November 1, 2010Federal Reserve Challenge: Bank of Chicago25  Current State of the Economy  Monetary Policy at Low Interest Rates  Options Available  Federal Open Market Committee Recommendation  Quantitative Easing  Support  Inefficiencies  Advantages  Interest on Excess Reserves  Conclusion
  26. 26. Advantages of Quantitative Easing November 1, 2010Federal Reserve Challenge: Bank of Chicago26  Stabilize Output  Catalyst for future economic growth  Maximize Employment  Begin to place downward pressure on the unemployment rate  Price Stability  Currently below the non-accelerating inflationary rate  Housing Market
  27. 27. Housing Market Index November 1, 2010Federal Reserve Challenge: Bank of Chicago27 Source: Board of Governors Federal Reserve and the Department of Commerce 0.00 25.00 50.00 75.00 100.00 125.00 150.00 175.00 200.00 225.00 250.00 275.00 300.00 January-00 January-01 January-02 January-03 January-04 January-05 January-06 January-07 January-08 January-09 January-10 Housing Starts Real Estate Loans 30Year Conventional Mortgage
  28. 28. Overview November 1, 2010Federal Reserve Challenge: Bank of Chicago28  Current State of the Economy  Monetary Policy at Low Interest Rates  Options Available  Federal Open Market Committee Recommendation  Quantitative Easing  Support  Inefficiencies  Advantages  Interest on Excess Reserves  Conclusion
  29. 29. Excess Reserves November 1, 2010Federal Reserve Challenge: Bank of Chicago29 -2.00 -1.00 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 January-00 January-01 January-02 January-03 January-04 January-05 January-06 January-07 January-08 January-09 January-10 Log of Excess Reserves Interest on Excess Reserves Source: Board of Governors Federal Reserve
  30. 30. Money Multiplier November 1, 2010Federal Reserve Challenge: Bank of Chicago30 0.50 0.70 0.90 1.10 1.30 1.50 1.70 1.90 2.10 January-00 January-01 January-02 January-03 January-04 January-05 January-06 January-07 January-08 January-09 January-10 Money Multiplier Source: Board of Governors Federal Reserve
  31. 31. Overview November 1, 2010Federal Reserve Challenge: Bank of Chicago31  Current State of the Economy  Monetary Policy at Low Interest Rates  Options Available  Federal Open Market Committee Recommendation  Quantitative Easing  Support  Inefficiencies  Advantages  Interest on Excess Reserves  Conclusion
  32. 32. Conclusion November 1, 2010Federal Reserve Challenge: Bank of Chicago32  Implement the second round of quantitative easing  Purchase long termTreasury Securities  Continue to hold mortgage backed securities to maturity  Continue to target the Federal Funds Rate at between 0 and 25 basis points  Lower the interest on excess reserves back to 0%
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