1. Chapter 9 - Monetary Policy Tools
Money and Banking – Michael Brandl ©2017 Cengage Learning

2. 9-1a Open Market Operations as a Monetary Tool
Most Flexible and most often used of the FED’s tools in the conduct of monetary policy
Buying and selling of government securities to influence the level of bank reserves
Contractionary OMO
Expansionary OMO
FED is not buying government securities directly from the Government but to and from a private entity
Money and Banking – Michael Brandl ©2017 Cengage Learning

3. 9-2 Monetary Policy Tools: Discount Window and Term Auction Facility
Primary Credit
Secondary Credit
Seasonal Credit
Stigma Effect

4. 9-2a When Traditional Policies Fail
Stigma effect during the summer of 2007
Banks must decide whether to lend the increases in reserves to customers
Firms and households would not be able to borrow funds needed for desired level spending
Term Auction Facility: a combination of OMOs and discount window lending
Money and Banking – Michael Brandl ©2017 Cengage Learning

5. 9-3a Emergency Lending
Problems arise in Financial Markets well beyond just depository institutions.
Investment banks, insurance companies did not have a lender of last resort
Fed created a collection of short-term lending facilities
Term Securities lending Facility
Primary Dealer Credit Facility
Asset-Backed Commercial Paper Money market Liquidity Facility
Money Market Investor Funding Facility
Commercial Paper Funding Facility
Term Asset-Backed Securities Loan Facility
Money and Banking – Michael Brandl ©2017 Cengage Learning

6. 9-3b Quantitative Easing
QE 1 (11/ /2010) – Fed announces the purchase of $100B direct debt from Fannie Mae, Freddie Mac and The Federal Home Loan Banks
500B of mortgage backed securities
Goal is NOT to reduce interest rates but to inject liquidity into the markets
The interest rate on a 30 year fixed rate drops by a whole 1 point
Money and Banking – Michael Brandl ©2017 Cengage Learning

7. 9-3b Quantitative Easing (cont’d)
QE2 (11/2010 – 6/2011)
FED buys 900B of Treasury Securities in a range of year maturities
QE3: June 2013 – Bernanke announces a tapering of Quantitative easing contingent on continued and improved economic conditions
Money and Banking – Michael Brandl ©2017 Cengage Learning

8. 9-3c Required Reserve Ratio
Could be a useful monetary policy tool; In reality it is seldom used.
Customer balances above a certain amount are swept out of a checking account and put into overnight accounts paying interest.
The rise of ATM’s: 70% of banks voluntarily have reserves that exceed the level of Required Reserves
Money and Banking – Michael Brandl ©2017 Cengage Learning

9. 9-4a Irving Fisher on Money Demand
1911 American Economist: Irving Fisher hypothesized 2 ways
Money used in transactions, how often each unit of money is used in a year
The total amount of transactions as the amount of goods & services bought within a year and the price level
Price Level x Transactions = GDP
Money and Banking – Michael Brandl ©2017 Cengage Learning

10. 9-4b John Maynard Keynes on Money Demand
3 motives for people to hold or demand money all of which revolve around interest rates
Liquidity preference theory
Transactional demand for money
Precautionary demand for money
Speculative demand for money
Money and Banking – Michael Brandl ©2017 Cengage Learning

11. 9-5a Liquidity Traps As an economy shows signs of weakness:
Businesses hold cash
Banks fear borrowers won’t repay loans
The economy slows not because of lack of liquidity or lack of cash but due to lack of Spending
Self-fulfilling prophecy
Money and Banking – Michael Brandl ©2017 Cengage Learning

12. 9-5a Liquidity Traps (continued)
Keynes famously argues that contractionary monetary policy works to slow the economy
Expansionary monetary policies are not effective in getting an economy out of a slow down
Money and Banking – Michael Brandl ©2017 Cengage Learning

13. 9-5b Government Budget Deficits and Monetary Policy
Monetization of public debt: Government either cannot or does not want to sell its bonds in the open market.
Due to high level of default risk
Government may not want the outside world to know how much it needs to borrow
When a government monetizes public debt, it is essentially forcing the banking system to create money for the government to spend.
Money and Banking – Michael Brandl ©2017 Cengage Learning

14. 9-6a ECB’s OMO: Tenders and Reserve Transactions
European Central Bank (ECB) – has four different tools
Main refinancing operations
Long term refinancing
Fine Tuning operations
Operations that provide structural liquidity
Money and Banking – Michael Brandl ©2017 Cengage Learning

15. 9-6a ECB’s OMO: Tenders and Reserve Transactions (continued)
Standard Tenders are settled in 24 hours
Quick tenders are normally executed within 90 minutes of the announcement of tender, and the funding takes place immediately after the announcement of who has won the auction.
Money and Banking – Michael Brandl ©2017 Cengage Learning

16. 9-6b ECB’s Deposit Facility
This facility is available for institutions with excess funds; it allows them to put the funds on deposit with the ECB and earn interest.
The interest rate on the deposit facility is normally 100 basis points below the ECB’s required minimum bid in open market or refinancing operations.
There is a two percentage point “corridor” between the interest rate floor provided by the deposit facility and the marginal lending rate ceiling
Money and Banking – Michael Brandl ©2017 Cengage Learning

17. 9-6c ECB’s Minimum Reserve Balances
The amount of reserves each institution must hold is determined by that institution’s reserve base.
Institutions must hold 2% reserves against short-term deposits (those that are eligible for withdrawal in two years or less) and short-term debt securities (those with maturities up to two years) that the institution has issued.
Institutions have zero reserve requirements on deposit and debt securities with maturities of more than two years and all repurchase agreements.
Money and Banking – Michael Brandl ©2017 Cengage Learning

18. Summary Traditional tools of monetary policy
OMOS
Discount window
Required reserves
Non-traditional monetary policy QE
Other means
Review of Money Demand theories
Liquidity trap
Debt monetization
ECB monetary policy