Monetary Policy Tools


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Monetary Policy Tools

  1. 1. Good afternoon, ladies and gentlemen. Thank you all for coming. For those of you who do not already know me, my name is Dvoretskih Anastasia. And today I plan to give you a short talk about the Monetary Policy Tools using as an example Federal Reserve Bank of New York. I’m sure this will be of great interest to everyone here. I've divided my presentation into three main sections. Firstly I’ll talk about open market operations and its impact on the whole economy. Then, I’m going to make an overview of what reserve requirements and discount window lending are. I shall only take about 5 minutes of your time. If you don’t mind I’ll deal with questions at the end of my talk. Now, let’s start. Central bank can use three policy tools to influence money supply and interest rates. They are: • Open market operations, which are directed at changing interest rate and monetary base • changes in reserve requirements. • Discount window lending Now let’s move on to the first part of my presentation, which is about Open market operations The most direct and frequently used way of changing the money supply is by raising or lowering the monetary base through open-market operations Open market operations are the most important and active tool of monetary policy that the Federal Reserve uses. These operations consist of the Federal Reserve buying and selling previously issued U.S. government securities, or debt warrants (also called “I owe you” = IOU) of the federal government. Open market operations influence on interest rate and monetary base in 2 ways. 1. When the Federal reserve wants to decrease monetary base Fed sells government securities on open market. It pays by debiting the accounts of commercial banks. The banks in turn debit its clients’ accounts. The banking system has fewer funds to lend. it put Upward pressure on the federal funds rate— the interest rate banks charge each other for overnight loans (loan for very short term, for example 1 day). Other interest rates in the economy also rise as a result. Slows the economy and curbs inflation. 2. When the Federal Reserve wants to increase monetary base Fed buys government securities from a firms that deals in them. It pays by crediting the account that the dealer’s bank has at the Fed. The bank in turn credits the dealer’s account. The banking system has more funds to lend. it causes Downward pressure on the federal funds rate. Influences other interest rates in the economy— which also go down. Gives the economy a boost. That’s all I have to say about open market operations and its impact on the economy. The next point I’d like to make is about Reserve requirements 1
  2. 2. Reserve requirements are the percentages of certain types of deposits that banks must keep on hand in their own vaults (хранилище) or on deposit at a Federal Reserve Bank. The Fed has the authority to set reserve requirements on checking accounts (текущие счета) and certain types of savings accounts. Reserve requirement Impact on bank lending Raised Reduce lending Lowered Increase lending The Fed rarely changes the reserve requirements. The last change made to the reserve requirement was in April 1992, when they lowered the rate from 12% to 10% of transaction deposits (такие депозиты (или вклады), средства с которых могут быть переведены другим лицам в виде платежей по сделкам, осуществляемым с помощью чеков или электронных денежных переводов). The Federal Reserve generally does not change the reserve requirement when there is an alternative way of achieving the same policy result. Those are the main points on reserve requirements. Now, let’s move on to discussing Discount window lending Discount window lending is lending reserves to banks so they can meet depositors’ demands or reserve requirements • The interest rate on such borrowing is called the discount rate • The Fed was set up to halt financial panics by acting as a lender of last resort through the discount window 2 types of monetary policy: 1. The aim - to check inflation. The FED raises discount rate - Economic activity slowed Increases in the discount rate generally reflect the Federal Reserve's concern over inflationary pressures 2. FED wants to pep economic growth Discount rate lowers - Economic activity stimulated decreases often reflect a concern over economic weakness. That completes my overview of monetary policy tools. And in conclusion I’d like to say that monetary policy aims to ensure price stability that may help long-term sustainable growth, low unemployment levels and equitable income distribution. Open market operations are the most important monetary policy instrument of all central banks. It is flexible in terms of timing and transaction volume when compared to alternative monetary policy instruments. Open market operations also may be used to implement inflation targeting monetary policy. And that’s why OMO are preferred by Central banks in all around the world rather than discount window lending and reserve requirements. Sources: 1. article OPEN MARKET OPERATIONS IN TURKEY GÖKHAN YILMAZ Research Department of The Central Bank of the Republic of Turkey 2. Federal Reserve Bank of NY web-site section “Financial Education” 3. Macroeconimics Andrew B. Abel, Ben S. Bernanke, Dean Croushore 2