Transcript Chapter 20 Understanding Movements in Bank Reserves Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

Chapter 20
Understanding
Movements in
Bank
Reserves
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
Learning Objectives
• Analyze the Federal Reserve balance sheet and
how changes in its assets and liabilities impact
the money supply
• Explain how the U.S. Treasury Department’s
spending decisions impact the money supply
• Understand the bank reserve equation
• Define the monetary base
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-2
Introduction
• The balance sheet of the Fed shows the movements of
reserves in the system
• Very complicated since many things can impact the
level of reserves
–
–
–
–
Open Market operations and Discounting
Other entries may offset movements in reserves
The Fed does not control many of these items
US Treasury can add or absorb bank reserves through fiscal
spending or tax revenue
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-3
Introduction (Cont.)
• Bank Reserve Equation
– The expanded view of reserve movements
– A summary sheet for sources and uses of reserves
– Useful for monitoring trends in reserves—
fundamental framework of monetary control.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-4
The Fed’s Balance Sheet
• Table 20.1 is a simplified balance sheet of the Federal
Reserve System in mid-2003
• Every item on the balance sheet (asset or liability) has
an effect on reserves
– Total assets = total liabilities
– Fed’s total liabilities include reserves—“bank deposits” in
the Fed plus cash in bank vaults
– Therefore, bank reserves must equal total Federal Reserve
assets minus all other Fed liabilities
– Anything affecting a Fed’s asset or liability must alter
reserves, unless it is offset somewhere else in the balance
sheet
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-5
TABLE 20.1 The Federal Reserve’s Balance
Sheet (March, 2008, in billions of dollars)
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-6
The Fed’s Balance Sheet (Cont.)
• ASSETS
– Gold certificates
• Gold purchased from abroad or from domestic mines
• US Treasury purchases gold with a check drawn on its deposit in the
Fed
• To replenish its checking account with Federal Reserve, Treasury
issues a “gold certificate” and the Fed credits the Treasury’s deposit
account by the same amount
• Federal Reserve assets have risen, but reserves are not affected (by
this transaction) since a liability other than reserves (Treasury
deposits) has risen simultaneously
• However, the net result of both the above transactions is an increase
in bank reserves
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-7
The Fed’s Balance Sheet (Cont.)
• ASSETS (Cont.)
– Coins—Coins and bills issued by the Treasury that the Fed
has in its vaults
– Loans—Bank borrowings from the Fed through the discount
window
– Term Auction Facility (TAF)—Federal Reserve auctions
short-term funds to banks who can then deliver a wide variety
of assets as collateral
– US government and agency securities
• Securities acquired by the Fed through open market operations
• Purchase of securities expands reserves
• Sales of securities by the Fed lowers reserves
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-8
The Fed’s Balance Sheet (Cont.)
• ASSETS (Cont.)
– Items in process of collection
•
•
•
•
Arises in process of clearing checks
“Deferred credit items” on the liability side.
The difference between the two is the “float”
Occurs because many checks are not collected within the specified
time period
• Float can fluctuate considerably, either adding to or subtracting from
reserves
• Can cause serious short-term disruptions in bank reserves
• As the use of electronic payment systems increases, float will
diminish in size and importance
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-9
The Fed’s Balance Sheet (Cont.)
• ASSETS (Cont.)
– Other Federal Reserve Assets
• Consists primarily of securities denominated in foreign
currencies
• Purchases and sales of foreign securities usually occur in
connection with foreign exchange operations of the Fed
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-10
The Fed’s Balance Sheet (Cont.)
• Liabilities
– Federal Reserve Notes Outstanding
• Liability to the Fed, but an asset to holder of the currency
• The change in this account does not alter bank reserves—notes
outstanding rises, bank deposits at Fed falls
• Impacted by the decision of the public to hold more currency, which
lowers bank reserves.
– US Treasury Deposits—Represents the “working balance”
of the Treasury reflected in spending and tax revenues
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-11
The U.S. Treasury’s Monetary
Accounts
• Purchase of gold
– Treasury, not the Fed, that officially buys and sells gold for
the government
– After purchasing gold by depleting reserves on deposit, the
Treasury issues an equal amount of gold certificates
– The Fed purchases these gold certificates to replenish the
Treasury’s deposit account
– When the Treasury buys gold, bank reserves rise and
when the Treasury sells gold, bank reserves fall
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-12
The U.S. Treasury’s Monetary
Accounts (Cont.)
• Changes in the Treasury’s deposits at the Federal
Reserve banks will affect bank reserves
• Currency issued by the Treasury
– The Treasury also issues a small amount of currency,
including all coins
– There is no difference between currency issued by
the Treasury or Fed, all coins and bills in bank vaults
count as reserves.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-13
The Bank Reserve Equation
• Table 20.2 shown in the textbook
• Record of sources and uses of bank reserves
• Primary difference between Table 20.1 and 20.2 is the
inclusion of Treasury currency in banks vaults which
are counted as reserves
• Consolidation of the Fed’s balance sheet with
Treasury’s monetary accounts
• Bank Reserves = bank deposits with Fed plus
currency in bank vaults
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-14
TABLE 20.2 The Bank Reserve Equation
(March, 2008; in billions of dollars)
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-15
Putting it all to Use
• In Chapter 18 it was assumed that the Fed could control
the volume of reserves by judicious use of open market
operations
• However, the reserve equation demonstrates that other
influences outside control of the Fed can affect reserves
• These outside influences need to be forecasted and
monitored to assist the Fed in controlling the level of
reserves
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-16
Putting it all to Use (Cont.)
• Defensive Measure
– Fed engages in open market operations aimed at
defending a target level of reserves from “outside”
influences.
– Offset transitory changes in reserves which are
trying to push level of reserves outside the range
desired by the Fed
– Extensive use of Repurchase Agreements as
temporary injections or deletions of reserves
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-17
Putting it all to Use (Cont.)
• Dynamic Measures—Open market operations
aimed at either increasing or deceasing the
overall level of bank lending capacity by
changing the level of bank reserves
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-18
Focusing on the Monetary Base
• What specific variable should the Fed attempt to
control to regulate money supply?
• Control variable (operating target) is the immediate
objective of open market operations
• It is suggested that the Fed should attempt to control
the monetary base—total reserves plus currency held
by the nonbank public.
• Reserve equation depicted in Table 20.2 can be altered
to focus on the monetary base.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-19
Appendix
MONETARY
EFFECTS OF
TREASURY
FINANCING
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
Appendix—Monetary Effects of
Treasury Financing
• Budget Deficit—when government spends more than it
receives in taxes
• Financing the deficit is the responsibility of the
Treasury Department
• Could print money to pay the bills, but this
responsibility falls under the Fed
• Treasury prints and sells bonds and uses proceeds to
meet its obligations
• Debt financing/Treasury spending complicates Fed’s
job of controlling money
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-21
Appendix—Monetary Effects of
Treasury Financing (Cont.)
• Taxation
– When taxes are paid, demand deposits at commercial
banks are transferred from private sector to
Treasury’s account
– Initially these funds are held in the Treasury’s
accounts at commercial banks
– Money supply falls since government deposits are
not counted in the money supply
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-22
Appendix—Monetary Effects of
Treasury Financing (Cont.)
• Taxation (Cont.)
– Total bank reserves fall when Treasury moves funds
from commercial banks to the Fed
– Money supply and bank reserves increase to
original level when the Treasury spends the
money
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-23
Appendix—Monetary Effects of
Treasury Financing (Cont.)
• Borrowing from Nonbank Public
– Rather than raise taxes, Treasury engages in deficit
spending— raising the money by selling bonds to
the nonbank public.
– Selling bonds reduces the money supply as funds are
transferred from the private sector to Treasury
accounts
– Reserves also fall when the Treasury shifts funds
from commercial banks to Fed
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-24
Appendix—Monetary Effects of
Treasury Financing (Cont.)
• Borrowing from Nonbank Public (Cont.)
– When the Treasury spends the money, both
money supply and reserves revert to their original
level
– Public winds up with government bonds rather than
a receipt saying they have paid their taxes.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-25
Appendix—Monetary Effects of
Treasury Financing (Cont.)
• Borrowing from Commercial Banking System
– Banks, rather than the public, purchases bonds
– Two possibilities
• Banks are fully loaned up
– Must dispose of other assets
– Reserves and money supply initially decrease, but are restored when
Treasury spends the money
• Banks have excess reserves
– No need to dispose of other assets
– Increases the money supply when the Treasury spends the money
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-26
Appendix—Monetary Effects of
Treasury Financing (Cont.)
• Borrowing from the Fed
– This method of borrowing does not reduce either the
money supply or bank reserves when the bonds are
sold
– The Treasury sells bonds to the Fed which deposits
the proceeds from the sale in the Treasury’s account
– When the Treasury spends the funds, both demand
deposits and the money supply increase
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-27
Appendix—Monetary Effects of
Treasury Financing (Cont.)
• Printing Money
– If the Treasury could print money, it could deposit
the newly created currency with the Fed
– When it spends the money, both bank reserves and
the money supply could increase
– This method is virtually identical to the case of
borrowing from the Fed
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-28
Appendix—Monetary Effects of
Treasury Financing (Cont.)
• Financing the deficit
– Deficit must be financed by one of the above options
– Fed decides how much will come from new money
and how much must come through the sale of bonds
to the public
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-29
Appendix—Monetary Effects of
Treasury Financing (Cont.)
• Financing the deficit (Cont.)
– Monetizing the Debt—Federal Reserve prints new money to
purchase the new Treasury bonds
• Could make the Treasury’s job easier by printing money—very
inflationary
• Congress created the Fed to keep the printing press from the Treasury
and force the Treasury to pay interest on its debt.
• When the Fed monetizes the debt by buying Treasury bonds, it lets
the Treasury print money through the back door
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
20-30