It did so on the theory that borrowed reserves made member banks reluctant to extend loans because their desire to repay their own indebtedness to the Federal Reserve as soon as possible was supposed to inhibit their willingness to accommodate borrowers. In the s, when the Federal Reserve discovered that open-market operations also created reserves, changing nonborrowed reserves offered a more effective way to offset undesired changes in borrowing by member banks.
In the s, the Federal Reserve sought to control what are called free reserves, or excess reserves minus member bank borrowing. The Fed has interpreted a rise in interest rates as tighter monetary policy and a fall as easier monetary policy. But interest rates are an imperfect indicator of monetary policy. If easy monetary policy is expected to cause inflation, lenders demand a higher interest rate to compensate for this inflation, and borrowers are willing to pay a higher rate because inflation reduces the value of the dollars they repay.
Thus, an increase in expected inflation increases interest rates. Between and , for example, U. Similarly, if tight monetary policy is expected to reduce inflation, interest rates could fall. From to , when Paul Volcker was chairman of the Federal Reserve, the Fed tried to control nonborrowed reserves to achieve its monetary target.
The procedure produced large swings in both money growth and interest rates. Forcing nonborrowed reserves to decline when above target led borrowed reserves to rise because the Federal Reserve allowed banks access to the discount window when they sought this alternative source of reserves.
Since then, the Federal Reserve has specified a narrow range for the federal funds rate, the interest rate on overnight loans from one bank to another, as the instrument to achieve its objectives. Although the Fed does not directly transact in the Fed funds market, when the Federal Reserve specifies a higher Fed funds rate, it makes this higher rate stick by reducing the reserves it provides the entire financial system.
When it specifies a lower Fed funds rate, it makes this stick by providing increased reserves. The Fed funds market rate deviates minimally from the target rate. If the deviation is greater, that is a signal to the Fed that the reserves it has provided are not consistent with the funds rate it has announced. It will increase or reduce the reserves depending on the deviation.
The Federal Reserve adopted an implicit target for projected future inflation. Its success in meeting its target has gained it credibility.
This increase in the ratio of money supply to GNP shows an increase in the amount of money as a fraction of their income that people wanted to hold. From to , nominal GNP tended to grow at a higher rate than the growth of the money supply, an indication that the public reduced its money balances relative to income.
Until , money balances grew relative to income; since then they have declined relative to income. Economists explain these movements by changes in price expectations, as well as by changes in interest rates that make money holding more or less expensive.
If prices are expected to fall, the inducement to hold money balances rises since money will buy more if the expectations are realized; similarly, if interest rates fall, the cost of holding money balances rather than spending or investing them declines. If prices are expected to rise or interest rates rise, holding money rather than spending or investing it becomes more costly.
Since a sustained decline of the money supply has occurred during only three business cycle contractions, each of which was severe as judged by the decline in output and rise in unemployment : —, —, and — The severity of the economic decline in each of these cyclical downturns, it is widely accepted, was a consequence of the reduction in the quantity of money, particularly so for the downturn that began in , when the quantity of money fell by an unprecedented one-third.
There have been no sustained declines in the quantity of money in the past six decades. The United States has experienced three major price inflations since , and each has been preceded and accompanied by a corresponding increase in the rate of growth of the money supply: —, —, and — An acceleration of money growth in excess of real output growth has invariably produced inflation—in these episodes and in many earlier examples in the United States and elsewhere in the world. Until the Federal Reserve adopted an implicit inflation target in the s, the money supply tended to rise more rapidly during business cycle expansions than during business cycle contractions.
The rate of rise tended to fall before the peak in business and to increase before the trough. Prices rose during expansions and fell during contractions. This pattern is currently not observed.
Growth rates of money aggregates tend to be moderate and stable, although the Federal Reserve, like most central banks, now ignores money aggregates in its framework and practice. A possibly unintended result of its success in controlling inflation is that money aggregates have no predictive power with respect to prices.
The lesson that the history of money supply teaches is that to ignore the magnitude of money supply changes is to court monetary disorder. Time will tell whether the current monetary nirvana is enduring and a challenge to that lesson.
Anna J. A decrease in the quantity of loans also means fewer deposits in other banks, and other banks reducing their lending as well, as the money multiplier that we discussed in Money and Banking takes effect. What about all those bonds? How do they affect the money supply? Read the following Clear It Up feature for the answer. Is it a sale of bonds by the central bank which increases bank reserves and lowers interest rates or is it a purchase of bonds by the central bank?
The easy way to keep track of this is to treat the central bank as being outside the banking system. When a central bank buys bonds, money is flowing from the central bank to individual banks in the economy, increasing the money supply in circulation.
When a central bank sells bonds, then money from individual banks in the economy is flowing into the central bank—reducing the quantity of money in the economy. If banks are required to hold a greater amount in reserves , they have less money available to lend out. If banks are allowed to hold a smaller amount in reserves, they will have a greater amount of money available to lend out.
The Fed makes small changes in the reserve requirements almost every year. In practice, the Fed rarely uses large changes in reserve requirements to execute monetary policy. A sudden demand that all banks increase their reserves would be extremely disruptive and difficult for them to comply, while loosening requirements too much would create a danger of banks inability to meet withdrawal demands. The Federal Reserve was founded in the aftermath of the Financial Panic when many banks failed as a result of bank runs.
As mentioned earlier, since banks make profits by lending out their deposits, no bank, even those that are not bankrupt, can withstand a bank run.
We call the interest rate banks pay for such loans the discount rate. Once depositors became convinced that the bank would be able to honor their withdrawals, they no longer had a reason to make a run on the bank.
In short, the Federal Reserve was originally intended to provide credit passively, but in the years since its founding, the Fed has taken on a more active role with monetary policy.
The third traditional method for conducting monetary policy is to raise or lower the discount rate. If the central bank raises the discount rate, then commercial banks will reduce their borrowing of reserves from the Fed, and instead call in loans to replace those reserves. Since fewer loans are available, the money supply falls and market interest rates rise. If the central bank lowers the discount rate it charges to banks, the process works in reverse.
In recent decades, the Federal Reserve has made relatively few discount loans. Before a bank borrows from the Federal Reserve to fill out its required reserves, the bank is expected to first borrow from other available sources, like other banks.
This is encouraged by the Fed charging a higher discount rate than the federal funds rate. Given that most banks borrow little at the discount rate, changing the discount rate up or down has little impact on their behavior. Select personalised content. Create a personalised content profile. Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights.
Measure content performance. Develop and improve products. List of Partners vendors. Central banks use several different methods to increase or decrease the amount of money in the banking system. These actions are referred to as monetary policy. While the Federal Reserve Board —commonly referred to as the Fed—could print paper currency at its discretion in an effort to increase the amount of money in the economy, this is not the measure used, at least not in the United States.
The Federal Reserve Board, which is the governing body that manages the Federal Reserve System, oversees all domestic monetary policy. They are often referred to as the Central Bank of the United States.
This means they are generally held responsible for controlling inflation and managing both short-term and long-term interest rates. They make these decisions to strengthen the economy, and controlling the money supply is an important tool they use.
The Fed can influence the money supply by modifying reserve requirements , which generally refers to the amount of funds banks must hold against deposits in bank accounts. By lowering the reserve requirements, banks are able to loan more money, which increases the overall supply of money in the economy.
Conversely, by raising the banks' reserve requirements, the Fed is able to decrease the size of the money supply. The Fed can also alter the money supply by changing short-term interest rates. By lowering or raising the discount rate that banks pay on short-term loans from the Federal Reserve Bank, the Fed is able to effectively increase or decrease the liquidity of money.
0コメント