Madura-FMI9e-IM-Ch04

Chapter4FunctionsoftheFedOutlineOrganizationoftheFedFederalReserveDistrictBanksMemberBanksBoardofGovernorsFederalOpenMarketCommittee(FOMC)AdvisoryCommitteesIntegrationofFederalReserveComponentsHowtheFedControlsMoneySupplyOpenMarketOperationsRoleoftheFed’sTradingDeskHowFedOperationsAffectAllInterestRatesAdjustingtheReserveRequirementRatioAdjustingtheFed’sLoanRateTheFed’sLendingRoleDuringtheCreditCrisisFacilitiesCreatedbytheFedGlobalMonetaryPolicyASingleEurozoneMonetaryPolicyGlobalCentralBankCoordination©2010CengageLearning.AllRightsReserved.ThiseditionisintendedforuseoutsideoftheU.S.only,withcontentthatmaybedifferentfromtheU.S.Edition.Maynotbescanned,copied,duplicated,orpostedtoapubliclyaccessiblewebsite,inwholeorinpart.2™Chapter4:FunctionsoftheFed©2010CengageLearning.AllRightsReserved.ThiseditionisintendedforuseoutsideoftheU.S.only,withcontentthatmaybedifferentfromtheU.S.Edition.Maynotbescanned,copied,duplicated,orpostedtoapubliclyaccessiblewebsite,inwholeorinpart.KeyConcepts1.DescribetheroleandtheorganizationoftheFed.2.ExplainhowmonetarypolicytoolsareusedbytheFedtocontroleconomicconditions.3.ExplainwhytheFed’smonetarypolicycannotignoreinternationalconditions.POINT/COUNTER-POINT:ShouldThereBeOneGlobalCentralBank?POINT:Yes.OneglobalcentralbankcouldserveallcountriesinthemannerthattheEuropeanCentralBanknowservesseveralEuropeancountries.Iftherewasasinglecentralbank,therecouldbeasinglemonetarypolicyacrossallcountries.COUNTER-POINT:No.Aglobalcentralbankcouldcreateaglobalmonetarypolicyonlyiftherewasasinglecurrencyusedthroughouttheworld.Moreover,allcountrieswouldnotagreeonthemonetarypolicythatisappropriate.WHOISCORRECT?UsetheInternettolearnmoreaboutthisissue.Offeryourownopiniononthisissue.ANSWER:Whiletheremaybesomebenefitsifthemonetarypolicywasconsistentamongcountries,itwouldbeimpossibletogetagreementamongallcountriesaboutthepolicytobeused.Countrieswouldnotwanttogiveuptheirpowertocontroltheirownmoneysupply.Questions1.TheFedVersusCongress.ShouldtheFedorCongressdecidethefateoflargefinancialinstitutionsthatarenearbankruptcy?ANSWER:TheFedmightarguethatthecreditcrisisisathreattothefinancialsystemandthatitneededtointervenetopreventabiggercrisis.SomecriticsmightarguethattheFedhastoomuchpowerandthatCongressshouldbeinvolvedindecisionsregardingtheuseoftaxpayerfundstorescuefinancialinstitutions.2.ReserveRequirements.Howismoneysupplygrowthaffectedbyanincreaseinthereserverequirementratio?ANSWER:Anincreaseinthereserverequirementratioreducestheproportionofdepositedfundsthatafinancialinstitutioncanlendout.Consequently,itreducestheratebywhichmoneycanmultiply.3.DiscountWindowLendingDuringCreditCrisis.ExplainhowandwhytheFedextendeditsdiscountwindowlendingtononbankfinancialinstitutionsduringthecreditcrisis.Chapter4:FunctionsoftheFed™3©2010CengageLearning.AllRightsReserved.ThiseditionisintendedforuseoutsideoftheU.S.only,withcontentthatmaybedifferentfromtheU.S.Edition.Maynotbescanned,copied,duplicated,orpostedtoapubliclyaccessiblewebsite,inwholeorinpart.ANSWER:In2008,theFedexpandeditsrolebylendingtoothertypesofinstitutions.InMarch2008,theFed’sdiscountwindowprovidedfundingtorescueBearStearns,alargesecuritiesfirmthatwasabouttogobankrupt.OnMarch16,2008,theFed’sdiscountwindowprovidedaloantoJ.P.MorganChasethatwaspassedthroughtoBearStearns.Thisensuredthattheclearingoperationswouldcontinueandavoidedliquidityproblems.Onthefollowingday,theFedexpandeditsrolefurtherbyannouncingthatitwouldprovideemergencyloanstotheabout20primarydealersthatserveaskeyfinancialintermediariesforthelargeTreasurysecuritiestransactionsinthesecondarymarket.Italsocommittedtoloansofupto$200billionofTreasurysecuritiestoprimarydealersforatermof28days(ratherthanovernight).Theseprovisionswereintendedtocalmthefinancialmarkets.4.TheBeigeBook.WhatistheBeigebookandwhyisitimportanttotheFOMC?ANSWER:TheBeigebookisaconsolidatedreportofregionaleconomicconditionsineachofthe12districts.ThisbookissenttoFOMCmembersbeforetheirmeetingsothattheyareupdatedonregionalconditionsbeforetheydecideonmonetarypolicy.5.OpenMarketOperations.WhydotheFed’sopenmarketoperationshaveadifferenteffectonmoneysupplythantransactionsbetweentwodepositoryinstitutions?ANSWER:WhentheFedengagesinapurchaseofTreasurysecuritiesfromadepositoryinstitution,moneyistransferredtothedepositoryinstitutionwithoutanyoffsetatanotherinstitution.However,asimilartransactionbetweendepositoryinstitutionswouldincreasetheaccountbalanceatoneinstitutionanddecreasetheaccountbalanceattheotherinstitution.6.PolicyDirective.Whatisthepolicydirective,andwhocarriesitout?ANSWER:ApolicydirectiveisestablishedbytheFedandsubmittedtotheTradingDesk.ThemanageroftheTradingDeskmustensurethatthedirectiveisachieved.7.OpenMarketOperations.ExplainhowtheFedusesopenmarketoperationstoreducethemoneysupply.ANSWER:TheFedcansellholdingsofitsexistingTreasurysecuritiestovariousdepositoryinstitutions,whichwillcauseareductionintheaccountbalancesoftheseinstitutions.8.OpenMarketOperations.ExplainhowtheFedincreasesthemoneysupplythroughopenmarketoperations.ANSWER:TheFedcanincreasem