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

1. Conducting Monetary Policy at
Low Short Term Interest Rates
Eric Cramer
November 1, 2010Federal Reserve Challenge: Bank of Chicago1

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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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%