The Federal Reserve’s Balance Sheet and Monetary Base Determination zBalance sheet of either one of the district banks, or the aggregate of all district banks (“The Federal Reserve Bank”)

The Federal Reserve’s Balance Sheet Securities Held Federal Reserve Discount Loans Notes Gold Certificates Bank Deposits SDR Certificates US Treasury Coin Held by Fed Deposits Float Foreign and Other Holdings of Deposits Foreign Currency Physical Capital Capital Account

Federal Reserve Assets zSecurities Held -- mostly T-Bills, used for open market operations zDiscount Loans -- loans advanced to banks at the discount rate zGold Certificates -- Fed converts gold obtained by US Treasury zSDR Certificates -- Fed converts Special Drawing Rights obtained in international trade.

More Fed Assets zCoin Held by the Fed zFloat -- cash items in the process of collection minus deferred availability cash items (check clearing) zHoldings of Foreign Currency -- used in exchange rate intervention zPhysical Capital

Federal Reserve Liabilities and Equity zFederal Reserve Notes Outstanding -- currency held by the public (C) + vault cash inside banks zBank Deposits at the Federal Reserve -- especially helpful in check clearing

The Monetary Base and the Fed’s Balance Sheet zConsider the sum of the first two components. (Federal Reserve Notes Outstanding) + (Bank Deposits at the Fed) = (C + Vault Cash Inside Banks) + (Bank Deposits at the Fed)

= (C) + (Vault Cash Inside Banks + Bank Deposits at the Fed) = (C) + (R) = H

The Fed’s Balance Sheet: Another Representation Securities Held Currency Held Discount Loans by the Public (C) Gold Certificates Bank Reserves (R) SDR Certificates US Treasury Coin Held by Fed Deposits Float Foreign and Other Holdings of Deposits Foreign Currency Physical Capital Capital Account

Still Another Representation Securities Held Monetary Base (H) Discount Loans US Treasury Gold Certificates Deposits SDR Certificates Foreign and Other Coin Held by Fed Deposits Float Holdings of Foreign Currency Physical Capital Capital Account

Other Federal Reserve Liabilities + Equity zUS Treasury Deposits zForeign and Other Deposits -- deposits of some foreign governments and central banks, world organizations. zCapital Accounts (Fed Equity) -- Federal Reserve is a profit maker, but not profit maximizer, allowed an equity-asset ratio of 3%.

The Federal Reserve as a Check Clearinghouse zExample -- Suppose you get a check of $100 from your parents, who bank at Citibank (within the NY district). You deposit it in your checking account (D) at your bank, Chase, in Syracuse.

Balance Sheet Description: The Banks Citibank  R -$100  D -$100 Chase  R +$100  D +$100

Balance Sheet Description: The Federal Reserve Federal Reserve Bank of New York  R -$100 (Citibank)  R +$100 (Chase) Any change in Bank Reserves is noted on the liability side of the Federal Reserve

Monetary Base Determination Identity -- Fed’s balance sheet. Securities Held + Discount Loans + Gold Certificates + SDR Certificates + Coin Held by the Fed + Float + Holdings of Foreign Currency + Physical Capital = H + US Treasury Deposits + Foreign and Other Deposits + Equity

The Monetary Base Equation Solve equation for H. (Securities Held + Discount Loans + Gold Certificates + SDR Certificates + Coin Held by the Fed + Float + Holdings of Foreign Currency + Physical Capital) – (US Treasury Deposits + Foreign and Other Deposits + Equity) = H

Monetary Base -- Sources zSources of the Monetary Base -- Items whose increase increases the monetary base. zExample -- Securities Held   H 

The Balance Sheet Description Fed buys a $100 bond from Chase. Federal Reserve  Securities +$100  R + $100 Held  H =  C +  R = $0 + $100 = $100

Monetary Base -- Uses zUses of the Monetary Base -- Items whose increase decreases the monetary base. zExample -- US Treasury Deposits   H 

The Balance Sheet Description The Federal Government collects $100 in taxes (people paying from their checkable deposits at Chase). Chase  R - $100  D - $100

The Federal Reserve’s Balance Sheet Federal Reserve  US Treasury Deposits + $100  R - $100 (Chase)  H =  C +  R = $0 + -$100 = -$100

Can the Fed Reasonably Control the Monetary Base? (Securities Held + Discount Loans + Gold Certificates + SDR Certificates + Coin Held by the Fed + Float + Holdings of Foreign Currency + Physical Capital) – (US Treasury Deposits + Foreign and Other Deposits + Equity) = H

Yes -- They Can Reasonably Control the Monetary Base zThe monetary base has components both controlled by the Fed and not controlled by the Fed. zBut, Securities Held is the largest component within the equation. zAnd, while changes in the other components may be large, they tend to be isolated and fairly predictable.

Sterilization of Undesired Changes in H The Federal Reserve can use open market operations to offset undesired changes in the monetary base -- sterilization

Sterilization -- An Example zSuppose that the Federal Reserve wishes to sterilize the decrease in H due to tax collection.  US Treasury Deposits + $100   H -$100,  Securities Held + $100   H +$100, Net effect:  H = $0.

Application -- Exchange Market Intervention zSuppose that the Federal Reserve is concerned about an excessive downward movement of the US exchange rate. It intervenes by using its holdings of foreign currency to buy dollars (then remove the dollars from the system).

Sterilized Versus Unsterilized Intervention zHoldings of Foreign Currency   H  zSterilized Intervention -- Fed performs an open market operation to offset this effect, Securities Held   H  zUnsterilized Intervention -- Fed does nothing, allows H to decrease.

Types of Open Market Operations zDefensive Open Market Operation -- Open market operations done to offset an undesired change in the monetary base. zDynamic Open Market Operation -- Open market operations done to initiate monetary policy.