previous CHAPTER 11
THE POLICY INSTRUMENTS
next

Chapters 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

Chapter 1
General Economic Concepts
Chapter 2
What is Policy?
Chapter 3
History of Macroeconomic Policies in the United States
Chapter 4
Policy Goals: Maximum Employment
Chapter 5
Policy Goals: Maximum Production
Chapter 6
Policy Goals: Price Stability
Chapter 7
Policy Goals: External Balance
Chapter 8
Subsidiary Policy Goals
Chapter 9
Conflicting Policy Goals
Chapter 10
The Policy Makers
Chapter 11
The Policy Instruments
Chapter 12
The Decision-Making Processes
Chapter 13
The Policy Indicators
Chapter 14
The General Economic Model
Chapter 15
Monetarist Monetary and Fiscal Policies
Chapter 16
Keynesian Monetary and Fiscal Policies
Chapter 17
Debt Management Policies
Chapter 18
Incomes Policies
Chapter 19
Supply Management Policies
Chapter 20
The Long Wave
Chapter 21
Contemporary Issues
"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill done."

John Maynard Keynes
British Economist
The General Theory of Employment, Interest and Money (1936)

  1. Fiscal Policies
  2. Monetary Policies
  3. Debt Management Policies
  4. Incomes Policies
  5. Supply Management Policies
  6. Supply-Side Economic Policies
  7. Summary
    Readings
    Websites
top    I. Fiscal Policies

Fiscal policies are budgetary policies. By manipulating its expenditures and tax revenues, the government can change the velocity of money, which, in turn, influences economic activity.

GDP = Y = PQ = f(Vy)|Ms

A budget shows the income and expenditure for an individual or institution over a period of time, generally one year. An ex post budget shows realized income and expenditure from past decisions. It provides a record or a history of income and expenditure over some past fiscal period. An ex ante budget shows planned income and expenditure for the future. It is a program or a plan for income and spending activity over some future designated fiscal period.

The ex ante and ex post budgets are separate and distinct, yet they are linked in the following sense. Plans for the future cannot be made independent of where the budget is today and it depends upon realizations of the past. Much of the ex ante budget is a result of decisions taken in the past, whereby the individual or institution becomes locked into a fixed pattern of income and expenditure. For the government, planned income — tax revenue — depends on the tax structure legislated some time in the past, and planned expenditure tends to follow from commitments and promises made to constituents in prior years. Since most of the federal government is operated through a well-entrenched bureaucracy of quasi-independent agencies, appropriations for these agencies tend to be perpetuated in subsequent budgets. In much the same fashion, the government has an ongoing legal responsibility to fund such social programs as Social Security and a fiduciary responsibility to service the interest on the national debt. Thus, the ex post budget becomes the model for the ex ante budget.

The federal government's budget is used to affect macroeconomic activity. State and local governments are limited, because they have constitutional mandates to plan balanced operating budgets and any imbalance has only limited regional affects.

The Federal Government Budget

The federal government budget lists the sources of funds on the left and the uses of funds on the right. The source of funds or income for the federal government is principally tax revenues, which are listed by type of tax. The uses of funds or the expenditures can be listed either by function or by agency. A functional budget allocates funds according to their use: to the program or function of the expenditure. A departmental budget allocates funds according to the user: to the agency or department which is responsible for such expenditure. The federal government's fiscal (accounting) year starts October 1 and ends September 30.

SOURCES OF FUNDS USES OF FUNDS
Income Expenditure (by function) Expenditure (by agency)
Taxes National Defense Legislative Branch
 Personal income taxes International Affairs and Finance The Judiciary
 Corporate income taxes Space Research and Technology Executive Office (President)
 Social insurance taxes Agriculture and Agricultural Resources Funds appropriated by the President
  Employment taxes and contributions Natural Resources Department of Agriculture
  Unemployment insurance Commerce and Transportation Department of Commerce
  Contributions for other insurance and retirement Community Development and Housing Department of Defense - Military
 Excise taxes Education and Manpower Department of Defense - Civil
 Estate and gift taxes Health and Welfare Department of Education
 Customs duties Veteran's Benefits and Services Department of Energy
Miscellaneous receipts Interest on the Public Debt Department of Health and Welfare
 Tolls General Government Department of the Interior
 Licenses Allowances Department of Justice
 Fees Adjustments Department of Labor
 Fines Undistributed intragovernmental transactions Department of State
 Sale of property   Department of Transportation
 Etc.   Department of Treasury
    NRC, GSA, NASA, VA, and other independent agencies
    Allowances
    Adjustments
    Undistributed intragovernmental transactions

Automatic Stabilizers

Automatic stabilizers are fiscal policy measures that have been built into the budget as a result of past legislation. They operate automatically as income rises and falls without further legislative action.

The Income Tax

incometax
Expansionary Deficit Contractionary Surplus
Assume that government expenditures (G) are planned exogenously by political forces, regardless of the level income (G). As income (Y) falls, tax collections (T) fall and the government is forced to run an expansionary budget deficit (D) to prevent economic collapse. The automatic tendency of the government to run an expansionary budget deficit during a contraction is called a fiscal dividend. The more progressive is the tax rate structure, the larger is the expansionary budget deficit as income falls. Assume that government expenditures (G) are planned exogenously by political forces, regardless of the level income (G). As income (Y) rises, tax collections (T) rise and the government is forced to run a contractionary budget surplus (S) to dampen an economic boom. The automatic tendency of the government to run a contractionary budget surplus during an expansion is called a fiscal drag. The more progressive is the tax rate structure, the larger is the contractionary budget surplus as income rises.

Proportional Income Tax With a proportional income tax and a constant marginal tax rate, tax revenues increase in proportion to income increases (tax curve Tprop):

Tax revenue = Tprop = tY

and

ΔTax revenue = tΔY

Progressive Income Tax With a progressive income tax and an incremental marginal tax rate, tax revenues go up when income goes up, but revenues rise more than in proportion to the increase in income, because higher incomes push individuals and corporations into higher marginal tax brackets and the tax rate (t) rises also (tax curve Tprog):

Tax revenue = Tprop = tY

and

ΔTax revenue = Δt ΔY

The progressive income tax is a better automatic stabilizer than the proportional income tax. As income rises and falls, the progressive income tax creates larger budget deficits (D2) and surpluses (S2) than does the proportional income tax (D1, S1).

Unemployment Compensation

Unemployment compensation is designed to supplement the income of persons who are temporarily laid off during a downturn in economic activity. Because these declines are expected to be short-lived, the payments are scheduled to be paid for only 26 weeks. If a downturn is especially protracted, Congress may extend the payment period to 39 weeks.

unemploymentcomp

Payments into the unemployment compensation fund (contributions) are made by those who are currently employed at a flat rate (t), T = tLe. Payments out of the fund (benefits) are made to those who are currently unemployed at a flat rate (g), G = gU. As employment and income rise (and unemployment falls), contributions rise in proportion to the increase in employment and benefits fall in proportion to the decrease in unemployment. The fund automatically runs a contractionary budget surplus (S). As employment and income fall (and unemployment rises), contributions into the fund fall in proportion to the decrease in employment and benefits out of the fund rise in proportion to the increase in unemployment. The fund automatically runs an expansionary budget deficit (D).

agprices
Agricultural Income Support Programs

Agricultural markets are subject to erratic weather conditions, the vagaries of demand and supply, and are extremely price competitive. Downturns in economic activity hit farm incomes harder than those of workers in the manufacturing or service sectors, where prices are administered. The agricultural price support programs are designed to supplement farm incomes when aggregate demand declines.

Without price supports, farm income would be Y0 = p0q0 when demand is D0. When demand declines to D1, farm income falls to Y1 = p1q1. With price support pf, farm income is stabilized at Yf = pfqs. When demand is D0, farm income from private sales is pfq2 and the government provides the difference in the form of a subsidy. When demand falls to D1, farm income from private sales falls to pfq3, and the government's subsidy to farmers is increased to make up the difference. Thus, payments to farmers and government expenditure on agriculture rise as income falls and fall as income rises.

Discretionary Expenditure Policies

Discretionary expenditure policies are fiscal policy measures that require special, repetitive legislative action. Each year, during the budget process, Congress and the President can alter the amount that is spent on individual programs and in the aggregate. Countercyclical fiscal policy calls for increasing government expenditure during a contraction and decreasing government expenditure during an expansion.

discretionaryexpchange

During a contraction, when income is falling (from Y1 to Y0), the government can offset the contraction by increasing its expenditure from G0 to G1 to incur an expansionary budget deficit (D). During an expansion, when income is rising (from Y0 to Y1), the government can offset the expansion by decreasing its expenditure from G1 to G0 to incur a contractionary budget surplus (S).

Direct Income Payments

The government may offer to make direct income payments to unemployed persons. This type of program is easiest and quickest to implement in a contraction and is also the easiest and quickest to stop when the economy recovers. Payments may be in the form of unemployment compensation or welfare grants. Direct income payments help to keep consumer spending from falling during a contraction, but may be debilitating where the work ethnic is pronounced. Direct income payments may also discourage persons from seeking gainful employment as long as the payments last.

Public Works Programs

The government may volunteer to provide gainful employment during contractions. The biggest problem is that programs tend to be mediocre and jobs are generally menial, e.g. picking up papers in Central Park.

If the public works programs are substantial and the jobs are significant, they may be pro-cyclical. Building bridges, roads, and dams requires extensive preparation and planning: from finding the available engineers to architectural design and blue-printing to contracting for supplies to completed construction. By the time construction gets underway, business activity may have picked up, in which case, the labor being used on the public works project are needed by business. Both the government and business end up spending at the same time, thus accentuating booms. Both the government and business also end up competing for resources in the same factor markets and financing in the same capital markets. The government spending may end up "crowding out" private spending as factor costs and interest rates are bid up.

To avoid this "crowding out" of private spending in the resource markets and financing in the capital markets, the government should stop work on the project immediately and wait for another contraction. However, this stop-and-go process would leave half-finished projects all over the country, possibly decaying until work is resumed. By the same token, if a public works project is worthwhile, it should be considered part of the budget and social overhead spending, regardless of the state of the economy. Alternatively, the government should maintain a "file" of projects to be started the minute a recession is recognized. This "file" would have to be updated periodically to keep projects current. Unfortunately, even economists have no way of knowing ahead of time how long or deep a contraction will be. This inability to forecast accurately the future adds to the constraints in terms of choosing an appropriate public works project for stabilization.

Cutting Government Expenditures

The government may find that cutting expenditure to offset an expansion is equally impossible, given the government's prior legal and fiduciary commitments and responsibilities. The entitlement programs, like social security, and interest payments on the national debt are two of these built-in structural biases that keep expenditure from falling. Besides, once individuals become accustomed to a certain level of government benefits, they are likely to vote out of office those public officials who cut these benefits. Elected officials who demand extensive reductions in federal spending and public benefits are committing political suicide.

Discretionary Tax Policies

Discretionary tax policies are fiscal policy measures that require special, repetitive legislative action. Congress and the President can change the aggregate amount of tax revenues by changing the level of tax rates, by changing the structure of tax rates, by changing tax credits and incentives, and by changing the taxable base. Countercyclical fiscal policy calls for decreasing tax revenues in a contraction and increasing tax revenues in an expansion.

Changing the Overall Level of Tax Rates and Collections

Countercyclical fiscal policy calls for lowering tax rates to reduce tax revenue in a contraction and for raising tax rates to raise tax revenue in an expansion.

discretionarytaxchange

If tax rate system is proportional, then a reduction in tax rates from t0 to t1 shifts the tax function down from T0 to T1 creating a deficit (D) during a contraction at Y0. An increase in tax rates from t1 to t0 shifts the tax function up from T1 to T0 creating a surplus (S) during an expansion at Y1.

Changing the Progressivity of Tax Rates

Changing the progressivity of the tax will not affect current tax revenues, if the shift is "revenue neutral." A "revenue neutral" shift in the tax rates will raise rates for some tax payers and lower them for others. Thus, the loss in revenues from those whose tax rates were lowered is offset by additional tax revenue from those for whom rates were raised. The shift from a proportional tax to a progressive tax (and vice versa) is "revenue neutral" at Yn, but not so at either a higher income level YH or a lower income level YL. In subsequent years, however, changes in income will affect the tax revenues of the government.

incometax

A shift from a flatter set of tax rates to a more progressive set of tax rates will tend to generate larger surpluses and deficits as the economy expands and contracts. A shift from a more progressive set of tax rates to a flatter set of tax rates will tend to generate smaller surpluses and deficits as the economy expands and contracts. If the shift is from less progressive tax rates to more progressive tax rates, the government will have a tendency to run larger surpluses (S2) in years when income rises and to run larger deficits (D2) in years when income falls. If the shift is from more progressive tax rates to less progressive tax rates, then the government will have a tendency to run smaller surpluses (S1) in years when income rises and to run smaller deficits (D1) in years when income falls.

Changing Tax Credits and Incentives

A tax credit is a direct reduction to the income tax liability, as opposed to a deduction or exemption that reduces the tax liability only indirectly by reducing taxable income:

Tax revenue = T = tY + (-TC)

and

ΔTax revenue = tY + Δ(-TC).

An increase in tax credits reduces the tax revenue of the government and forces an expansionary budget deficit. A reduction or elimination of tax credits raises the tax revenue of government and forces a contractionary budget surplus.

Changing the Taxable Base

The principal tax base for federal revenues is the income of households and corporations. To the earned and unearned income of these units, the government permits certain deductions and exemptions:

Tax revenue = T = t(Y+(-(D + E))) + (-TC)

and

ΔTax revenue = T = t(Y+(-(ΔD + ΔE))) + (-TC)

By increasing the number and value of deductions and exemptions, the government reduces the taxable base and, subsequently, its own revenues. By reducing or eliminating deductions and exemption, the government increases the taxable base and, subsequently, its own revenues. In the first instance, the government is forced to run an expansionary budget deficit and, in the second instance, the government is forced to run a contractionary budget surplus.

The High Employment Surplus Budget

The High Employment Surplus Budget (HES) or Full-Employment Budget measures the potential deficit, surplus, or balance that would occur if the economy were at full employment (Yf). The state of balance in the federal budget at full employment indicates whether the actual budget surplus (deficit) is contractionary (expansionary) or expansionary (contractionary). How expansionary (contractionary) a budget deficit (surplus) is depends on the nature of balance at full employment rather than the actual balance.

hesbudget

The HES Budget is calculated by estimating tax revenue from what would have been full-employment income and subtracting actual government expenditure. If the HES Budget is in surplus (SHES), then the actual deficit (Da) at Y0 is contractionary. If the HES Budget is in deficit (DHES), then the actual deficit (Da) at Y0 is expansionary.

top    II. Monetary Policies

Monetary policies involve changing the money supply and interest rates.

GDP = Y = PQ = f(Ms)|Vy

Where fiscal policy uses the flow variables of taxing and spending to influence macroeconomic activity, monetary policy uses the stock variable, money supply, and its price, the interest rate, to influence macroeconomic activity. The interest rate is the annualized percentage of principal that is paid for the use of money.

Money is a generalized claim on all other assets both now and in the future. Money supply is that asset or group of assets that acts as money. The Federal Reserve calculates several monetary aggregates in order to keep track of an appropriate money supply. The most commonly used measure is M2.

The Federal Reserve Balance Sheet

The first step in understanding monetary policy is understanding the Federal Reserve's balance sheet. A balance sheet is the financial picture of an individual or institution at a point in time.

FEDERAL RESERVE CONSOLIDATED BALANCE SHEET
Assets Liabilities
Gold certificate account
Special Drawing Rights (SDR) certificate account
Cash
Securities
—U.S. Government Securities
—Federal Agency Securities
    –GSE discounted notes
    –GSE mortgage-backed securities
—Acceptances
—Commercial Paper
    –Unsecured paper
    –Asset-backed paper
Loans
—Discounts and Advances to banks
—Special loans to banks
    –Maiden Lane I
    –Citibank Lending
    –Bank of America Lending
    –Other Loans
—Loans to non-banks
    –Primary Dealer Credit Facility
    –AIG
    –Maiden Lane II
    –Maiden Lane III

Cash items in the process of collection

Bank Premises and Equipment

Other assets
Federal Reserve Notes Outstanding
Deposits
—Depository Institutions (Reserves)
—U.S. Treasury (General Account)
—Foreign (Official Accounts)
—Other deposits



















Deferred Availability Cash Items

Other Liabilities and Accrued Dividends
Capital accounts
—Capital Paid In
—Surplus
TOTAL ASSETS TOTAL LIABILITIES & NET WORTH

Assets

Gold certificate account Except for some actual gold certificates that district banks use for educational displays, all "gold certificates" are simply bookkeeping entries. When the U.S. Treasury buys gold and wants to replenish its dollar balances, it "monetizes" the gold by issuing gold certificate credits to the Federal Reserve. To sell gold which has been monetized, the Treasury must redeem gold certificate credits by reducing its balances at the district banks.

Special Drawing Rights certificate account The special drawing right (SDRs) is an international monetary reserve asset created by the International Monetary Fund (IMF) in 1970 for use by governments only in official balance-of-payments transactions. It is similar to a share of stock in the IMF. The Treasury monetizes these SDRs through its Exchange Stabilization Fund (ESF), included in the "Deposits: Other" liability account. The ESF, established by the Gold Reserve Act of 1934, is used primarily as a vehicle to help counter disorderly foreign exchange market conditions and to finance exchange-related, short-term credit arrangements with foreign governments. In monetizing SDRs, the Treasury issues SDR certificate credits (bookkeeping credits) to the Federal Reserve Bank of New York (FRBNY), for which it receives an equal amount of dollars credited to its ESF account at the FRBNY. These SDR credits are ultimately distributed by the FRBNY to other district banks.

Cash Cash consists of coin and paper currency. District banks periodically buy coins minted at face value from the Treasury's Bureau of the Mint and paper currency (Federal Reserve notes) from the Treasury's Bureau of Printing and Engraving. This activity enables the district banks to maintain inventories of coin and paper currency at levels, which permit them to fill orders from depository institutions to meet currency demands. Inventory levels are based upon historical demand patterns with additional provision for normal demand growth. The district banks arrange, in advance, for shipments of new coin and paper currency in amounts and on a schedule to maintain inventories at required levels. The district banks pay for this currency by increasing the deposit accounts of the Treasury.

In addition, the Federal Reserve acts as a last resort depository for surplus currency of the banking system. When depository institutions accumulate excess amounts of currency from daily transactions, they ship the surplus to their respective district banks and take credit in their reserve accounts. When the depository institutions run short of currency, they simply call their respective district banks and have the additional currency shipped to them. They pay for the new currency from their reserve accounts.

Securities The Federal Reserve is authorized in the ordinary course of business to buy U.S. government securities, agency securities, and acceptances and to discount commercial, agricultural, and industrial paper. [Federal Reserve Act, Sec. 13(2,6,7)]
    U.S. Government Securities U.S. government securities are general obligations of the federal government, issued by the Treasury. These securities include the Treasury bills, notes, and bonds. Treasury bills, sold at discount, have maturities not exceeding one year. Treasury notes, which have an interest coupon, have maturities of not less than one nor more than 10 years. Treasury bonds, also bearing an interest coupon, are issued with maturities in excess of 10 years. On rare and infrequent occasion, the Treasury may issue certificates of indebtedness directly to the Federal Reserve to provide temporary financing, not to exceed one year. Except for the Treasury certificates held outright, the Federal Reserve holds U.S. government securities under both outright and repurchase and reverse repurchase agreements.

    Almost all transactions are conducted through the primary dealers. Sometimes securities are bought from foreign official accounts. Except for acquisitions in exchange for maturing issues, direct purchases from the Treasury are permitted only for short periods and for relatively small amounts. All marketable U.S. government securities are now issued in book-entry form rather than as paper certificates and are carried on the Fed's books at face value. Premiums paid are carried as "other assets" and discounts received are carried as "other liabilities" on the balance sheet. Both are amortized over time.

    Federal Agency Securities Federal agency securities are issued by government sponsored enterprises (GSEs) that were established by acts of Congress. They were called to life to implement, primarily, the U.S. government's farm and home lending programs. Each agency has the authority to issue its own securities. Most agency securities are not guaranteed by the U.S. government, but are obligations only of the agencies. However, in the event of a cash shortage, these agencies have the authority to borrow directly from the U.S. Treasury. Such authority ensures that they are almost as risk-free as U.S. government securities.

    All transactions are conducted through the primary dealers. In 1966 an amendment to the Federal Reserve Act authorized district banks to buy and sell federal agency securities under repurchase and reverse repurchase agreements. In 1971, the FOMC extended this authorization to outright purchases and sales to widen the base of open market operations and to add breadth to the market for agency securities. In April 1972, the FOMC authorized the Manager of the System Open Market Account (SOMA) to use competitive bidding when buying agency securities under repurchase and reverse repurchase agreements.

    In 1977, the FOMC restricted outright purchases and sales to securities of those agencies which are unable to borrow from the Federal Financing Bank. These "eligible" securities include issues from the Federal Home Loan Banks, the Federal National Mortgage Association, the Federal Land Banks, the Federal Intermediate Credit Banks, the Banks for Cooperatives, and the Federal Financing Bank. Ineligible securities include issues of the General Services Administration, the U.S. Postal Service, the Washington Metropolitan Transit Authority, the Export-Import Bank, the Farmers Home Administration, and the Government National Mortgage Association.

    Agency securities are now issued in book-entry form rather than as paper certificates and are carried on the Fed's books at face value.

    Acceptances Acceptances are letters of credit which have been accepted by banks as their own obligations. In 1955, the Federal Open Market Committee (FOMC) authorized the FRBNY to deal in prime bankers' acceptances for its own account. In 1977, the FOMC modified this authorization to include repurchase and reverse repurchase agreements only. All purchases are conducted through a select group of approximately forty primary dealers. Although bankers' acceptances are bought and sold at a discount prior to maturity, they are carried on the FRBNY's books at face value.

    Commercial Paper Commercial paper is short-term highly-rated unsecured and asset-backed commercial paper from eligible issuers via eligible primary dealers.
Loans Loans are extensions of credit, in the form of either discounts or advances, by the Federal Reserve to depository institutions and other selected individuals and institutions, including partnerships, corporations, foreign governments, and foreign central banks. A discount is a loan that is based upon the "purchase" of a third party's debt or "paper" at a discounted value (factoring). An advance is a loan that is signed by the borrower and collateralized by a third party's debt or "paper." The Federal Reserve may also make special purpose loans to the banks and banks holding companies and, under exigent circumstances, it may make loans to individuals, partnerships, and non-bank institutions.
    Discounts and Advances The Federal Reserve Act originally enabled borrowers to obtain credit only through the rediscount of eligible paper. [Federal Reserve Act, Sec. 13(2)] In this manner, borrowers endorsed and sold to the district banks' customers short-term commercial, industrial, or agricultural paper. However, the detail involved in rediscounting large numbers of individual notes and other kinds of paper was burdensome. For administrative convenience, to effect economies in operation, and presumably to aid in the financing of World War I, Congress, in 1916, amended the Federal Reserve Act to permit district banks to make short-term advances to member banks against their own notes secured by eligible paper, bonds or notes of the U.S. [Federal Reserve Act, Sec. 13(8)] Today, eligible paper is restricted to U.S. government securities (T-bills, T-notes, and T-bonds), federal agency securities, municipal securities, bankers' acceptances, some commercial paper issues, and mortgage loans covering one-to-four-family residences. Many banks keep eligible paper at their district bank or a branch, thus making collateral, particularly residential mortgage loans, available on their own premises for periods not in excess of 21 days or at an off-premises location under custody.

    Special Loans to Commercial Banks

      Maiden Lane LLC

      Maiden Lane LLC is a limited liability holding company that was created to bail out non-bank companies. It has been funded on several occasions by the Federal Reserve Bank of New York to facilitate these bailouts. Maiden Lane I made loans to JP Morgan Chase to buy the assets of Bear Stearns.

      Press Release, FRB BOG, 3 Jul 2008
      Support for specific institutions, FRB BOG, updated as of 29 April 2009

      Citibank Lending

      Press Release, FRB BOG, Nov 2008
      Support for specific institutions, FRB BOG, updated as of 29 April 2009

      Bank of America Lending

      Press Release, FRB BOG, 15 Jan 2009
      Support for specific institutions, FRB BOG, updated as of 29 April 2009

      Other Loans These loans to banks and bank holding companies are intended to facilitate the purchase of commercial paper and asset-backed commercial paper from money market mutual funds.

    Loans to Non-Bank Companies The Federal Reserve may lend directly to individuals, partnerships, and non-bank institutions under an obscure provision in its enabling statute [Federal Reserve Act, Sec. 13(3)]. In the 2007-2009 financial crisis, the Federal Reserve exercised this option to open non-bank credit facilities and to lend to non-banks.

      Primary Dealer Credit Facility The Primary Dealer Credit Facility (PDCF) is a credit facility that makes collateralized loans of money to non-bank primary dealers at a fixed rate of interest. The borrowing is overnight, but is renewable for up to 120 days, subject to a frequency-based fee after 30 days of use within the first 120 business days of the program. The current interest rate is equal to the primary credit rate at the Federal Reserve Bank of New York. Eligible collateral consists of a broad range of securities beyond eligible securities, including all investment-grade corporate securities, municipal securities, mortgage-backed securities, and asset-backed securities for which a price is available.

      The PDCF is similar to the primary credit facility (PCF), except that the PCF services depository institutions and the PDCF services primary dealers who are not depository institutions. Previously, only depository institutions had the ability to borrow from the Federal Reserve (through the district bank PCFs). Now, the PDCF authorizes primary dealers who are not depository institutions to borrow from the Federal Reserve. Also, the PDCF accepts a broader range of acceptable collateral than is acceptable at the PCF.

      Borrowing at the PDCF is at the discretion of the primary dealers. PDCF loans increase the amount of total reserves in the banking system, in much the same way that primary credit loans do. Therefore, the Manager of SOMA must closely monitor borrowings when conducting OMO with an eye to achieving a specific target for the federal funds rate.

      The PDCF was created on March 16, 2008 to provide financing to participants in securitization markets and to promote the orderly functioning of financial markets more generally. The PDCF was conceived as a temporary (6 month) measure to ensure market liquidity. Nothing has been said yet about extending it or about making it a permanent institution.

      On Sunday, September 14, 2008, as the 2008 financial crisis worsened and Lehman Brothers, Merrill Lynch, and AIG teetered on the verge of collapse, the Federal Reserve announced that it would expand the types of securities that investment banks could pledge as collateral for their loans from the Fed. The pool of acceptable securities was expanded to include equities, junk bonds, subprime mortgage-backed securities, and even whole mortgages. This list closely matches that of the "tri-party" overnight lending facilities run by two major clearing banks — JPMorgan Chase and Bank of New York. Those programs allow about 15% of their collateral to be pledged in equities or debt that is below investment-grade, and most of that is reserved for equities.


      Press Release, FRB BOG, 14 Sep 2008
      Press Release, FRB BOG, 2 Dec 2008
      Lending to primary dealers, FRB BOG, updated as of 2 Apr 2009. Click here for Securities Lending Facility

      American International Group The Federal Reserve made a direct loan in the sum of $85 billion to American International Group (AIG), currently, the largest American insurance company. It subsequently increased the loan to $140 billion. The collateral for the loan is ownership in AIG. The Federal Reserve received a 79.9% stake in the insurance giant.

      Press Release, FRB BOG, 16 Sep 2008
      Support for specific institutions, FRB BOG, updated as of 29 April 2009

      Maiden Lane LLC

        Maiden Lane II was funded to purchase of residential mortgage-backed securities (RMBS) from AIG. Maiden Lane II was authorized to buy and manage those assets through time to maximize repayment of the credit extended and to minimize disruption to financial markets.

        Maiden Lane III was funded to purchase of certain multi-sector collateralized debt obligations (CDOs) from certain counterparties of AIG. Maiden Lane III was authorized to buy and manage those assets through time to maximize repayment of the credit extended and to minimize disruption to financial markets.
Cash items in the process of collection This category is composed of checks and other items (negotiable orders of withdrawal and matured corporate and municipal coupons) from depository institutions payable on demand which the Federal Reserve accepts as cash items. These items have been received by district banks and, on the date of the statement, are in the process of being collected, or transported to the institutions on which they are drawn. On individual district bank balance sheets this category includes items to be collected from other district banks. On the consolidated statement, items in transit between district banks are deleted. To include them would be double counting.

Bank Premises and Equipment This category includes the value of the land and buildings, at initial cost, of district banks and branches, less an allowance for depreciation on buildings.

Other assets consist of accumulated interest and other accounts receivable, premiums paid on securities bought outright, U.S. notes, silver certificates, and assets denominated in foreign currencies, including "swap" drawings and funds "warehoused" for the Treasury and the ESF.

Liabilities

Federal Reserve Notes Outstanding These notes are debt obligations of the Federal Reserve Banks and include the total amount of these notes in circulation, including those held at depository institutions and the U.S. Treasury.

Deposits
    Depository Institutions Reserves These accounts are demand balances that banks and other depository institutions (Edge Act Corps. and the U.S. agencies and branches of foreign banks) are legally required to hold against customer demand, time, and savings deposits and other deposits against which marginal reserve requirements have been applied, e.g. Eurodollar borrowings.

    U.S. Treasury General Account This account is the official checking account of the Treasury, from which virtually all U.S. government disbursements are made. It is the total of all demand balances held by the Treasury at the various district banks and their branches.

    Foreign Official Accounts These accounts are the demand balances of foreign governments, foreign central banks, and the Bank for International Settlements. While transactions for these accounts are handled by the FRBNY, the deposits are allocated among all district banks.

    Other deposits include demand balances for international organizations such as the International Monetary Fund, the United Nations, and the International Bank for Reconstruction and Development (World Bank); the special checking account of the ESF; and demand balances of certain U.S. government agencies.
Deferred Availability Cash Items These items include checks and other cash items which, although received by the district banks, are not due to be credited for one or two business days. District banks defer credit according to a schedule which allows time for out-of-town checks to be mailed or delivered to the depository institutions on which they are drawn. The maximum deferral is two business days, after which the depositing institution's reserve account is credited regardless of whether the item is collected from the depository institution on which it is drawn. The difference between "Cash Items in the Process of Collection" and "Deferred Availability Cash Items" is called float:

Float = Cash items in the process of collection - Deferred availability cash items

Other Liabilities and Accrued Dividends consists of accrued dividends on paid-in capital stock by member banks, unearned discounts on securities bought outright, sundry items payable, accrued expenses, and reserves against foreign exchange contracts which have not been booked.

Capital Accounts

Capital Paid In Capital paid in is the amount paid for Federal Reserve capital stock. Member banks are shareholders by law and must subscribe to shares of the Reserve Bank of their district in an amount equal to 6% of their own paid-in capital stock and surplus. Of this amount, 3% must be paid in and 3% remains subject to call by the BOG. When a member bank changes its capital and surplus, its ownership of district bank stock is altered accordingly.

Surplus After necessary expenses are paid and the statutory cumulative 6% dividend on paid-in capital is met, district banks are required by law to pay net earnings into a surplus fund. This surplus must be equal in size to the amount of paid-in capital.

Changes in the Federal Reserve's Balance Sheet

Traditionally, since the consolidation of the Federal Reserve System in 1933, the Fed has carried a large volume of U.S. government securities as assets on its balance sheet. The purpose of holding U.S. government securities is twofold: First, U.S. government securities provide a safe and secure income for the Federal Reserve, which is independent of the federal government, not funded by the federal government, and must earn its own income. Second, the Manager of SOMA at the New York District Bank uses U.S. government securities for the conduct of monetary policy. It buys and sells the securities to add and drain reserves from the banking system (open market operations).

With the publication of the subprime mortgage crisis in August 2007, two things happened: First, the Federal Reserve's balance sheet expanded by 260% from $869 billion in assets to $2,268 billion in assets.

A COMPARISON OF AUGUST 31, 2007, WITH DECEMBER 31, 2008
assets
Source: Federal Reserve Board of Governors, Table h.4.1
liabilitites
Source: Federal Reserve Board of Governors, Table h.4.1

Second, the composition of the balance sheet changed. Starting with the announcement of term lending and a narrowing of the PCF-fed funds spread in August 2007, the Federal Reserve shifted its monetary policy emphasis from open market operations to lender of last resort strategies.

CHANGE IN COMPOSITION OF ASSETS AND LIABILITIES
assets
Source: Federal Reserve Board of Governors, Table h.4.1
liabilitites
Source: Federal Reserve Board of Governors, Table h.4.1

Notice that the Fed's holdings of U.S. government securities decreased significantly as the Federal Reserve opened many new and different types of lending facilities to non-bank financial institutions to circumvent frozen credit markets and the lack of available credit through traditional channels.

The Federal Reserve's Balance Sheet, Ben S Bernanke, Speech at the Federal Reserve Bank of Richmond 2009 Credit Markets Symposium, Charlotte, NC, 3 April 2009
The Role of the Federal Reserve in Preserving Financial and Monetary Stability, Joint Statement by the Department of the Treasury and the Federal Reserve, 23 Mar 2009
Credit and Liquidity Programs and the Balance Sheet, FRB BOG, last updated 23 Feb 2009

The Reserve Equation

The reserve equation yields a first approximation for determination of reserves for the banking system. It is derived from the Federal Reserve balance sheet.

The Reserve Equation as an Identity

The balance sheet accounting identity (identity) shows that the two sides of a balance sheet must always balance. As an identity, the reserve equation shows that the two sides of the Federal Reserve's balance sheet always balance:

Total Assets identity Reserves + Other Liabilities + Net Worth

The Reserve Equation as an Functional Equation

A functional equation (=) rearranges an identity into cause and effect. As a functional equation, the reserve equation shows that the determination of reserves is a residual from other changes in the Federal Reserve's balance sheet.

Reserves = Total Assets - (Other Liabilities + Net Worth)

Anything that increase assets or decreases other liabilities and net worth increases reserves, ceteris paribus. Anything that decreases assets or increases other liabilities and net worth decreases reserves, ceteris paribus.

In addition to reserves held in deposits at the Fed, banks are permitted to count, as part of their reserve requirement, cash in bank vaults. However, cash in bank vaults is fluid and moves back and forth between banks and deposits at the Fed and between banks and the public. Consequently, actions taken by individuals and institutions outside the Fed have an impact on the reserves of the banking system.

The Monetary Base

The monetary base (B), also known as high powered money, takes into consideration all perfectly substitutable assets that provide potential reserve bases for money creation by the banking system:

B identity RF + Cb + Cp identity RT + Cp identity RF + CT

where RF is reserves held on deposit at the Fed, Cb is cash in bank vaults, and Cp is cash in the hands of the public. The three items are perfect substitutes for one another and, simply by transfer of ownership, they affect the amount of reserves in the banking system. Total reserves (RT) include reserves at the Fed (RF) plus cash in bank vaults (Cb). Total Treasury currency outstanding (CT) includes cash in bank vaults (Cb) plus cash in the hands of the public (Cp). Therefore, an analysis of the reserve position of banks requires knowledge of the factors that both supply and drain portions of the monetary base from the system.

MB = Factors supplying reserves - Factors absorbing reserves

Factors Supplying Reserves to the Monetary Base

Federal Reserve Credit
    Open market operations is the purchase and sale of U.S. government securities by the Manager of SOMA at the FRBNY. When the Manager of SOMA buys securities, it takes securities from the banks and the public and, in return, pays for the securities with injections of new reserves. If the Manager of SOMA buys securities from banks or other depository institutions, it directly credits their reserve accounts. If the Manager of SOMA buys securities from the public, it gives them checks, which they deposit into their banks and depository institutions and, upon presentment to the Fed, the banks and other depository institutions receive credit in their reserve accounts. When the Manager of SOMA sells securities, it gives securities to the banks and the public and, in return, withdraws reserves from the system. If the Manager of SOMA sells the securities to banks or other depository institutions, it directly debits their reserve accounts. If the Manager of SOMA sells securities to the public, it receives their checks and, upon presentment to the paying banks and other depository institutions, debits their reserve accounts.

    Discounts and advances are loans to depository institutions and authorized non-depository institutions. When a district bank lends to a depository institution, it directly credits the institution's reserve account. When the institution repays its loans, the district bank debits the institution's reserve account. When a district bank lends to a non-depository institution, it gives a check to the institution, the institution deposits the check into an account at a depository institution, and, upon presentment to the Fed, the Fed credits the recipient depository institution's reserve account. When the non-depository institution repays its loan, it gives a check to the Fed, the Fed presents the check to the paying depository institution for collection, and debits the paying depository institution's reserve account.

    Other loans are loans to authorized non-depository institutions under exigent circumstances.

    Pure quantitative easing is the purchase and sale of all other types of eligible securities by the Manager of SOMA and loans at the FRBNY.

Float is the difference between "cash items in the process of collection" and "deferred availability cash items." The extent of float depends upon the policy of the Fed to credit items in the process of collection to reserve accounts of banks and on the rapidity of transportation and communication through which credit items are collected. The Fed's current policy is to credit banks receiving credit items from banks within a district on a 24-hour basis. These items remain outstanding for only one day, regardless of the actual collection time. For banks in different reserve districts, the credit policy is 2 days, regardless of the actual collection time. The actual collection time depends on how fast credit items can travel — transportation facilities, transportation schedules, weather, labor problems, computer breakdowns, etc. which are factors outside Fed control. The longer it takes to clear checks physically, the larger the float is and the larger reserves are.

Gold stock The U.S. government maintains a stock of gold at Fort Knox, Kentucky. When it wants to monetize portions of the gold stock, the Treasury issues new gold certificates to the Fed, who, in turn, credits the Treasury's General Account. When the Treasury spends these balances, reserves are added to the banking system. When the government sells gold, it can use the proceeds to retire or buy back gold certificates, draining reserves from the banking system. Monetizing the gold stock is a discretionary action of the U.S. government (Treasury), not the Fed.

Special Drawing Rights certificates When the U.S. government opts to settle official account balances with other countries, it can "spend" SDRs. The Treasury issues SDRs to the Fed, who, in turn, credits the Treasury's General Account. These balances are initially transferred to official foreign balances; however, as foreigners buy commodities and assets from the U.S., these balances are transferred to the reserve accounts of banks. Monetizing SDRs is a discretionary action of the U.S. government (Treasury), not the Fed.

Miscellaneous Federal Reserve assets Any increase in accumulated interest and other accounts receivable, premiums paid on securities bought outright, U.S. notes, silver certificates, and assets denominated in foreign currencies, including swap drawings and funds warehoused by the Treasury and the Exchange Stabilization Fund (ESF), will increase reserves, ceteris paribus. Any decrease in accumulated interest and other accounts receivable, premiums paid on securities bought outright, U.S. notes, silver certificates, and assets denominated in foreign currencies, including swap drawings and funds warehoused by the Treasury and the ESF, will decrease reserves.

Treasury currency outstanding By definition, all Treasury currency is legal tender and considered payment for debts, public and private. Whenever the Treasury issues new currency, it adds to total currency outstanding. If the new currency remains in the hands of the public, no new reserves are created; however, when it is deposited in banks, it becomes part of bank reserves. Banks can either hold this currency in their vaults or deposit it with the Federal Reserve. Under the Constitution, the federal government has only the power to mint coin. In times past, the Treasury issued gold and silver certificates that represented deposits of gold and silver with the Treasury. Today, the Treasury only mints token coin for circulation. The Federal Reserve is responsible for putting paper notes into circulation. How much of either remains in circulation or is deposited in banks depends upon the currency requirement of the public and is outside the control of the Fed.

Factors Absorbing Reserves from the Monetary Base

Treasury deposits at the Fed Treasury deposits at the Fed will vary as taxes are collected and monies expended. The Treasury maintains Tax and Loan Accounts at the commercial banks. These accounts facilitate the collection of taxes as well as minimize the impact on reserves. By simply transferring funds within the banking system from the accounts of the tax-paying public to the Tax and Loan accounts of the Treasury, no reserves are lost. When the Treasury wants to spend its tax receipts, it transfers funds from its Tax and Loan accounts to its General Account at the Fed. This transfer drains reserves from the banks, but only temporally, until such time as spending by the Treasury returns deposits and reserves to the banks and the public.

Foreign deposits at the Fed In the course of international trade and finance, payments are made by Americans to foreigners, and vice versa. When Americans make payments to foreigners, balances are transferred from the reserve accounts of banks to foreign official accounts, thus draining reserves from the banking system. When Americans receive payments from foreigners, balances are transferred from foreign official accounts to the reserve accounts of banks, thus increasing reserves to the banking system. Since these actions are a result of the normal course of international business activity, they are outside Fed control.

Other deposits at the Fed Again, other deposits at the Fed, which include demand balances for international organizations and government agencies, will rise and fall as the owners receive and expend balances in the normal course of economic activity.

Treasury cash holdings When the Treasury recalls a previous currency issue, as it has with its "greenbacks" and the gold and silver certificates, or when the Treasury receives cash as payment for taxes, fees, fines, or other remittances, total currency outstanding declines. This reduces the potential reserves of the banking system at the option of the paying agent, not the Fed.

Miscellaneous Federal Reserve liabilities As the Fed records accrued dividends on paid-in capital stock by member banks, unearned discounts on securities bought outright, sundry items payable, accrued expenses, and reserves against foreign exchange contracts which have not been booked, its miscellaneous liabilities will rise, at the expense of reserves; and vise versa. Miscellaneous liabilities are generally outside the direct control of the Fed: the dividend on paid-on capital is fixed; discounts on securities bought depend upon financial market conditions at the time of purchase; accounts payable and accrued expenses result from ongoing operations; and reserves against foreign exchange contracts which have not been booked depend upon international financial movements.

Total Reserves

Total reserves depend upon potential reserves; namely, upon the factors supplying reserves and the factors absorbing reserves.

RT = B - Cp = RF + Cb = Rr + Re = Rn + Rb

Out of potential reserves, the amount of total reserves depends upon the currency requirement of the public. Actual total reserves are then divided into required reserves (Rr), which are used to support existing deposit liabilities, and excess reserves (Re), which can be used by banks to make loans, extend deposit liabilities, and increase the money supply. Actual total reserves are either the result of deposits and open market operations (nonborrowed reserves (Rn)) or of borrowing at the discount window (borrowed reserves (Rb)).

Net Free Reserves

Net free reserves (Rf) are the nonborrowed excess reserves of the banking system:

Rf = Rn - Rr = Re - Rb

General Monetary Policy Controls

General controls are theoretically the non-discriminatory tools of monetary policy. They include changing the monetary base and/or changing the money multiplier.

All money supplies take the same form: Ms = mB, where Ms is the money supply, B is the monetary base (or high powered money), and m is the money multiplier. The monetary base includes reserves at the Federal Reserve, cash in bank vaults, and cash in the hands of the public:

B identity RF + Cb + Cp identity RT + Cp identity RF + CT

The money multiplier includes all of the assets in the designated money supply in the numerator and all of the restrictions on its expansion in the denominator. These restrictions include reserve requirements, currency requirements and bank policies regarding excess reserve holdings. The number and types of restrictions depend on the technical definition of the money supply.

If Ms = C, where C = currency, and there are no demand deposits or possibilities for monetary expansion through lending excess reserves, then m = 1 and Ms = 1B.

If Ms = D, where D = demand deposits and banks can expand the money supply by lending excess reserves, then m = {1/(r + e)}, where r = reserve requirement and e = ratio of excess reserves to demand deposits, and Ms = {1/(r + e)}B.

If Ms = D + C, where both currency and demand deposits circulate as money, then m = {(1 + c)/(r + e + c)}, where c = C/D, the public's desired currency ratio, and Ms = {(1 + c)/(r + e + c)}B.

If Ms = D + C + T, where T = savings and time deposits, then m = {(1 + c + t)/(rd + trt + e + c)}, where t = T/D, the public's desired savings deposit ratio and rt is any reserve requirement against savings and time deposits, and Ms = {(1 + c + t)/(rd + trt + e + c)}B.

Changes in Federal Reserve credit, discount rate policy (d) and open market operations (OMO), change the monetary base (B) and changes in reserve requirements (r) change the money multiplier (m).

General controls are considered to be general, and, therefore, non-discriminatory, in that they are applied independent of their effect on specific economic participants or specific markets. Rather, they are designed to affect the money supply in the aggregate and interest rates across-the-board. However, even general controls may be discriminatory in that interest-sensitive sectors of the economy will be more reactive than will sectors that are not sensitive to or dependent upon interest rates for their general level of economic activity. Markets for capital goods, housing, automobiles, and other consumer durables are generally more heavily affected by changes in the general controls than are markets for food and clothing. The financial markets are also heavily influenced by changes in the general controls, because financial asset prices depend upon interest rates for discounting future income flows and capital gains. The general controls are implemented through operating targets in the federal funds market.

The Federal Funds Market

The federal funds market is the market in which banks with excess reserves lend to banks with deficient reserves.The federal funds rate is the inter-bank lending rate in the federal funds market.

Equilibrium in the federal funds market occurs where the supply of federal funds equals the demand for federal funds. The total amount of reserves equals nonborrowed reserves plus borrowed reserves. Nonborrowed reserves are represented by the blue line and the difference between total reserves and the blue line represents borrowed reserves. Nonborrowed reserves come from open market operations and borrowed reserves come from bank borrowing at the discount window.

FEDERAL FUNDS MARKET
fedfundsmkt fedfundsmkt
When the discount rate (id) is above the federal funds rate (iff), banks do NOT borrow reserves. The banks have only nonborrowed reserves (NBR) from OMO and QE. The Federal Reserve can raise or lower the discount rate and the change has no impact on the federal funds rate. When the discount rate (id) is below the federal funds rate (iff), banks borrow reserves at the lower rate (Rb) and then turn around and lend them to other banks at the higher rate. This borrowing increases total reserves (RT). Total reserves = NBR + Rb. When the Federal Reserve raises (lowers) the discount rate, the supply of reserves (Rs) decreases (increases), total reserves decrease (increase) and the federal funds rate rises (falls).

The Federal Reserve can influence the federal funds rate by changing federal reserve credit and reserve requirements. When the Federal Reserve changes the discount rate, it influences total reserves by changing the amount of borrowed reserves. When the Federal Reserve conducts open market operations, it influences total reserves by changing the amount of nonborrowed reserves. When the Federal Reserve changes reserve requirements, it affects the demand for reserves.

FEDERAL FUNDS MARKET
fedfundsmkt fedfundsmkt
When the Manager of SOMA buys (sells) T-bills, nonborrowed reserves (NBR) increase (decrease) and the federal funds rate (iff) falls (rises). When the reserve requirement increases (decreases), the demand for reserves Rd increases (decreases) and the federal funds rate (iff) rises (falls).

Equilibrium in the fed funds market, Robert E. Wright and Vincenzo Quadrini, Money and Banking

Federal Reserve Credit: Nonborrowed Reserves

The Federal Reserve supplies nonborrowed reserves to the banking system through open market operations (OMO).

Open Market Operations

Open market operations is the purchase and sale of securities in the "open market" for the Federal Reserve's System Open Market Account (SOMA). The open market is the secondary market. The Manager of SOMA at the FRBNY buys and sells U.S. government securities to regulate nonborrowed reserves, credit expansion, and the money supply. The Manager of SOMA is not allowed to buy securities directly from the Treasury, except in certain limited instances, noted above.

The function of open market operations is to influence economic activity by changing the amount of nonborrowed reserves in the banking system. Open market operations is active reserve management, undertaken at the Fed's initiative. To stimulate the economy, the Manager of SOMA buys securities. When the Manager of SOMA buys securities, it pays for them by crediting reserve accounts. With new reserves, depository institutions can extend credit and expand the money supply. To slow down the economy, the Manager of SOMA sells securities. When the Manager of SOMA sells securities, it reduces reserves. With fewer reserves, depository institutions are forced to either recall loans or refuse additional loans, thereby contracting credit and the money supply.

Eligible securities for OMO are prime bankers' acceptances, federal agency obligations (except for securities issued by the General Services Administration, U.S. Postal System, Washington Metropolitan Area Transit Authority, Export-Import Bank, Farmers Home Administration, and the Government National Mortgage Association), and U.S. government securities (except for Treasury certificates issued exclusively to the Fed for very short-term financing). The bulk of all OMO transactions are conducted with T-bills and the other securities are generally held for income. The federal government securities may be either bought outright or bought and sold through repurchase and reverse repurchase agreements.

Today, all U.S. government securities and federal agency securities are issued in computerized book-entry form rather than certificate form. By eliminating certificates, the securities are better safeguarded and more rapidly transferred throughout the financial system. They are less vulnerable to theft and loss, cannot be counterfeited, and do not require recording by certificate number. Owners need not "clip" coupons to obtain interest payments or present the certificates for redemption. Interest is automatically paid on the due date and the securities are automatically redeemed at maturity.

In conducting open market operations, the Manager of SOMA can make outright purchases and sales or negotiate repurchase and reverse repurchase agreements. An outright purchase or sale is considered to be non-reversible transaction in the short-run. A repurchase agreement or a reverse repurchase agreement (match-sale repurchase agreement) is a temporary, self-reversing transaction.

A repurchase agreement (RP) is an agreement to "buy back" securities. It temporarily adds reserves to the banking system. When the Fed conducts a repurchase agreement, it buys securities from a dealer with an agreement that obligates the dealer to buy the securities back on or before a specific date.

A reverse repurchase agreement (RRP) or a match-sale repurchase agreement (MSRP) is an agreement to "sell back" securities. It temporarily drains reserves from the banking system. When the Fed conducts a reverse repurchase agreement, it sells securities to a dealer with an agreement that obligates the dealer to sell back the securities on or before a specific date.

RPs and RRPs may be arranged for a period of up to 15 days. Most multi-day contracts can be terminated at the dealer's option. The Fed also has this option, but rarely exercises it. Some contracts, however, are arranged for fixed periods and may not be shortened by either party. Acceptable securities for RPs and RRPs include U.S. government securities, federal agency securities, and prime bankers' acceptances.

The Manager of SOMA conducts two different types of OMO operations. Dynamic operations are designed to make longer-term permanent changes in the reserve position of the banking system. They move the federal funds rate from one level to another level. Defensive operations are daily adjustments to the basic reserve position. They are used to offset unanticipated inflows and outflows of reserves. An outright purchase or sale of securities is used for both dynamic operations and defensive operations. Repurchase and reverse repurchase agreements are used to stabilize the reserve position for short periods of time.

At the beginning of a two-week reserve maintenance period, the Manager of SOMA makes a best guestimate of the expected average daily excess or shortfall of reserves in the banking system. It then arranges either a 15-day RP to add reserves against an expected shortfall or a 15-day RRP to drain reserves against an expected excess. The Manager of SOMA may then make small outright purchases and sales on interim days to fine tune the reserve position. This combination of RPs, RRPs, and outright purchases and sales is intended to minimize disruptions and dislocations in the financial markets.

A Short History of Open Market Operations In 1913, when Congress passed the Federal Reserve Act, the government had very little outstanding debt. In fact, the open market operations function of the Fed was to act as an underwriter for Treasury issues, buying and selling Treasury securities to ensure adequate financing at low rates. Not until World War I did the Treasury float enough debt to make open market operations a viable alternative to the discount rate for controlling money and credit in the banking system. However, after World War I, the Treasury, true to its liberal classical (laissez-faire) tradition, began to repay its debt.

Before the government could complete its repayment, the economy slid into its most serious depression. Tax revenues, no longer tied to imports as they were in the 19th century but rather to income (since ratification of the 16th Amendment in 1913), declined, forcing ever larger budget deficits and mandating additional debt issues to cover government expenditures. The political issue facing Hoover and Roosevelt in the 1932 election was the restoration of a balanced budget. After his election, however, Roosevelt and the Congress went on a spending spree, adding to the national debt at an unprecedented rate for a peacetime government. Then, with the outbreak of World War II and the massive military build up, the government borrowed even more.

At the end of World War II, the federal government had over $250 billion in debt outstanding. While this figure pales against today's $13.0 trillion national debt, it was ten times as large as the $25 billion in debt outstanding at the end of World War I and over one hundred times as large as the national debt in 1915. In retrospect, 65 years after World War II, our national debt is 46 times as large as it was in 1946, while the debt after World War II was ten times as large as the debt only 26 years earlier at the end of World War I. In other words, the federal government has accumulated debt since World War II faster than it accumulated debt in the years between the World Wars.

After World War II, the Federal Reserve actively pursued open market operations as a tool of monetary policy, as well as a means for creating liquid reserves for the banking system. Its operations were thwarted in the early 1950s by the Treasury's demand to obtain low-cost financing in the credit markets for the Korean conflict. The Fed wanted slightly higher interest rates; the Treasury did not. In order to accommodate the Treasury, the Fed was forced to buy up much of the Treasury's debt, adding to the reserves of the banking system and increasing the money supply. In 1951, the dispute between the Treasury and the Federal Reserve came to a head, and, after much public dickering, the two parties agreed to an Accord, whereby the Fed was freed of the shackles of financing Treasury offerings. However, the ties were loosened only slowly, and for many years after, part of the Fed's open market operations were conducted with one eye toward favorable financing terms for the Treasury.

While arguments for cooperation between the Treasury and the Federal Reserve are convincing, excessive accommodation eliminates the effectiveness of open market operations as a tool of monetary policy. Today, open market operations are conducted principally with achievement of the ultimate goals in mind. Open market operations are considered the most powerful and effective tool of monetary policy and are relied on especially to "fine tune" monetary targets.

OMO have certain strengths and weaknesses. The strengths of open market operations are:
  1. Open market operations is the most flexible tool. The Manager of the Manager of SOMA determines the amount, magnitude, and timing of securities trades.

  2. Open market operations is the tool over which the Fed has the most control in altering reserves. Unlike borrowing at the discount window which depends upon the initiative of the banks, the Manager of the Manager of SOMA initiates open market trades.

  3. Open market operations can be used to support the discount rate policy. An increase in the discount rate may be ineffective in contracting or slowing the rate of credit and money growth, if banks have excess reserves. To support the higher discount rate, open market operations, through the sale of securities, will drain the excess reserves and force banks to ration credit. A decrease in the discount rate may be ineffective in expanding the rate of credit and money growth, if banks have no excess reserves. To support the lower discount rate, open market operations, through the purchase of securities, will add reserves and permit banks to extend more credit and increase the money supply.

  4. Open market operations can be used to supplement reserve requirements. Sometimes reserve requirements are changed for structural rather than stabilization purposes. Open market operations can be used to offset undesired changes in the reserve position of the banking system.

  5. Open market operations can be used to affect different interest rates in various ways. Because of the variety of maturities on securities, the Fed can buy and sell securities of different maturities to alter the term structure of interest rates.
The weaknesses of open market operations are:
  1. Open market operations lack an announcement effect. Open market operations are conducted on an ongoing, daily basis. Almost every day, the Manager of SOMA is authorizing either purchases or sales of U.S. government securities to stabilize the federal funds rate around the FOMC target rate. Target rates are announced only after FOMC meetings or telephone conference calls initiating a change in the federal funds target rate.

  2. Open market operations fail to signal the stance of Fed policy. The public cannot distinguish between purchases and sales for dynamic purposes and purchases and sales for defensive purposes. The stance of Fed policy can be determined only from dynamic operations.

  3. The initial impact of open market operations is concentrated in the money market centers, where the primary dealers are located. This impact may take time to filter through the economy. While this filtration time appeared to be decreasing through the mid-2000s, given the vast network of correspondent banks, computerization of the fed funds market, and the use of electric funds transfer systems, sometimes the impact does not filter at all. This failure to filter was evident in the financial crisis of 2007-2009. Initally, the FOMC brought the federal funds target down to a range between 0 and 25 basis points and the Manager of SOMA bought billions of dollars in T-bills to flood the banking system with reserves to achieve this target. However, the banks preferred to sit on these new reserves and not to lend them. The Federal Reserve had to resort to trading longer-term Treasuries and asset-backed mortgage securities to deal with interest rates in specific maturity markets and to lending directly to non-bank institutions in order to keep the money supply and the financial system from collapsing.
Overall, the strengths and weaknesses of OMO make it an ideal tool for short-term fine-tuning of monetary policy. However, the Federal Reserve has learned a belatedly sad lesson, namely, that OMO is not sufficient for times of deep financial crisis where, for example, the banks exhibit an extremely strong liquidity preference and refuse to make loans.

Federal Reserve Credit: Borrowed Reserves

The Federal Reserve supplies borrowed reserves to the banking system through the extension of two types of credit. The first type of credit is a variable amount of reserves that are loaned by the district banks to their member banks at a fixed rate through their primary credit facilities at the primary credit rate. The second type of credit is a fixed amount of reserves that are auctioned by the New York District Bank to the highest bidding banks at variable rates through the term auction facility.

The Primary Credit Facility and the Primary Credit Rate

The primary credit facility, previously called the discount window, is the place where depository institutions can borrow reserves. When Congress passed the Federal Reserve Act in 1913, it was concerned with providing a liquidity valve for preventing credit crunches, financial panics, and economic collapses. Congress assumed that the discount window would play a major role in preventing such occurrences by providing lender of last resort facilities. Since economic and credit conditions were expected to vary by district, Congress authorized the Boards of Directors of the individual district banks to set the discount rate in accordance with local economic and credit conditions. By acting as a lender of last resort, the district banks were to maintain liquidity according to economic and credit conditions in each district.

Prior to the passage of the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA), borrowing at the discount window was a privilege generally restricted to commercial banks that were members of the Federal Reserve System. Since DIDMCA, all depository institutions are eligible to borrow at their district bank's discount window. The price that depository institutions pay for their borrowing is called the discount rate.

The primary credit rate or the discount rate (d) is the base rate at which the Federal Reserve district banks lend to depository institutions in their respective districts. It is expressed in annual terms (i.e., a 365- or 366-day year) and interest charges are computed on the basis of the number of days funds are actually advanced. Interest on borrowings from the discount window is payable when the loan is repaid.

The effective rate depends upon the kind of credit being extended by the Federal Reserve district bank to the depository institution. The district banks offer four kinds of credit: primary, secondary, seasonal, and emergency.

Primary credit is available to generally sound depository institutions on an overnight or a very short-term basis as a backup rather than as a regular source of funding. On August 17, 2007, the primary credit program was temporarily changed to allow loans for terms of up to 30 days to ensure sufficient liquidity in light of the "mortgage meltdown" crisis.

Prior to January 9, 2003, the primary credit rate was set below the FOMC's target for the federal funds rate. Depository institutions were required to exhaust all other sources of funds before coming to the discount window and their purpose(s) for borrowing were restricted. On January 9, 2003, the Federal Reserve repositioned the discount rate from below the FOMC's target for the federal funds rate to above the FOMC's target for the federal funds rate. The repositioning was intended to improve the discount window's operation as a mechanism for implementing monetary policy. Since the repositioning, depository institutions do not need to exhaust all other sources of funds before coming to the discount window and they are not restricted to the purpose(s) for borrowing.

From January 9, 2003, to August 17, 2007, the primary credit rate was set 100 basis points above the FOMC's target for the federal funds rate. The goal of the 100 basis point spread was to encourage depository institutions to obtain regular funding from market sources rather than from the discount window and to discourage depository institutions from borrowing at the discount window to lend in the federal funds market. However, the "mortgage meltdown" crisis in August 2007 persuaded the Federal Reserve to reduce this spread to 50 basis points and to encourage borrowing. On August 17, 2007, the Board of Governors approved district bank requests to lower the primary credit rate by 50 basis points to effect the lower spread. On September 18, 2007, the primary credit rate was lowered by another 50 basis points to 5.25% (at the same time that the FOMC lowered the federal funds target rate to 4.75%).

Secondary credit is extended on a very short-term basis to depository institutions not eligible for primary credit. It is available to meet backup liquidity needs when its use is consistent with a timely return to market sources of funding or the orderly resolution of a troubled institution. The secondary credit rate is set 50 basis points above the primary credit rate. As of September 18, 2007, the secondary credit rate is 5.75%.

Seasonal credit is available to help relatively small depository institutions meet regular seasonal needs for funds that arise from a clear pattern of intra-yearly movements in their deposits and loans and that cannot be met through special industry lenders. The discount rate on seasonal credit takes into account rates charged by market sources of funds and ordinarily is reestablished on the first business day of each two-week reserve maintenance period. As of September 18, 2007, the secondary credit rate is 5.35%.

Emergency credit is available in unusual and exigent circumstances. The Board of Governors may authorize a district bank to provide emergency credit to banks, individuals, partnerships, and corporations that are not depository institutions. The rate charged to qualified depository institutions is one to two points above the primary credit rate. The rate charged to other institutions is generally set three points above the primary credit rate.

The actual rate depends on the collateral pledged by borrowing institutions and/or surcharge attachments. A borrower is charged the base rate (by credit type) when pledging Treasury securities, federal agency securities and eligible paper as collateral. A surcharge of at least one-half a percentage point is added to the base rate when other paper is pledged.

The discount rate is set by the directors of each district bank every 14 days, subject to review and approval by the Board of Governors. Any change is usually effective the day after the BOG's action, regardless of whether the following day is a business day. Prior to World War II, each district generally had a different discount rate. Since World War II and the consolidation of the Federal Reserve, the discount rate at all district banks is identical, except for periods of a few days depending upon when the district bank's Board meets to reset the rate.

The function of the discount rate is to regulate the amount of reserves in the banking system by regulating borrowing at the discount window. The district banks raise and lower the discount rate to decrease and increase the amount of borrowed reserves in the banking system. An increase in the discount rate decreases reserves via repayment of discount loans and a decrease in the discount rate increases reserves via new borrowings at the discount window. An increase in the discount rate raises the cost of funds to banks and therefore discourages borrowing to increase reserves and expand the money supply. A decrease in the discount rate lowers the cost of funds to banks and therefore encourages borrowing to increase reserves and expand the money supply. As the amount of borrowed reserves in the banking system decreases and increases, total reserves decrease and increase. As total reserves decrease and increase, the federal funds rate rises and falls.

Raising and lowering the discount rate raises and lowers the federal funds rate. The federal funds rate is the inter-bank lending rate in the federal funds market. The federal funds market is the market in which banks with excess reserves lend to banks with deficient reserves.

Whether the district banks were unable or unwilling to stem the money supply contraction with its use of the discount rate during the Depression, Congress decided to shift the rate-making authority to the BOG. While the district banks are still responsible for proposing rates and rate changes, the BOG must approve district bank requests and is ultimately responsible for the discount rate, as part of monetary policy.

As a tool of monetary policy, a change in the discount rate affects the cost of borrowing and the availability of funds for loans in three ways. First, it changes the banks' cost of funds when borrowing directly from the discount window. Second, it affects the whole structure of interest rates by altering the opportunity cost to banks of obtaining reserves from securities to raise reserves. If the rate goes up, banks will liquidate short-term securities; this will put downward pressures on prices and upward pressure on short-term interest rates. The gap between short- and long-term rates will narrow. As the gap narrows, investors will sell long-term securities and buy short-term securities, finally pushing longer-term rates higher. Third, a change in the discount rate can be interpreted as a signal by the Fed of its future intentions. If the discount rate is raised, banks may begin to restrict loans to customers in anticipation of higher rates. If the discount rate is lowered, banks may push aggressively for new loan applications by offering lower rates.

The discount rate has certain strengths and weaknesses. The strengths of the discount rate are:
  1. Changes in the discount rate provide a temporary means of adjustment for reserve deficiencies that occur at times of pressure on reserves. It allows the Manager of the Manager of SOMA to be more aggressive in pursuing, especially, a "tight" money policy, knowing that banks can correct deficient reserve positions by borrowing at the discount window.

  2. Changes in the discount rate have an announcement effect. They signal both banks and the general public as to the general direction of Federal Reserve policy. Unfortunately, the announcement effect may be bad if the signal is misinterpreted. As the Fed tries to align rates, a change in the discount rate may be interpreted as a directional shift in monetary policy, when, in fact, the Fed has simply changed the rate to reflect already existing market conditions.

  3. Changes in the discount rate serve as a guide to the Manager in conducting open market operations. Since the Fed tries to keep the discount rate and the fed funds rate in close proximity of one another, a change in the discount rate that opens the gap between the two rates signals the Manager to conduct open market operations so that the fed funds rate gravitates toward the discount rate.

  4. Changing the discount rate gives monetary policy decision-makers another option, should open market operations become unworkable. The importance of the discount rate as a tool of monetary policy has fallen to second place behind open market operations. However, it may have to act as a very important secondary tool in an emergency. If, for example, the securities markets should collapse, the discount rate may be the only practical way of providing or withdrawing reserves from the system.
The weaknesses of the discount rate are:
  1. Changes in the discount rate cannot force banks to borrow. The demand for new reserves depends directly upon the opportunities for lending. If the demand for bank loans is low, the demand for borrowing at the discount window will be low. A decrease in the discount rate will not have the desired effect of increasing reserves, if banks already have excess reserves because the demand for bank loans is low.

  2. Changes in the discount rate cannot force banks to stop borrowing. Again, the demand for new reserves depends directly upon the opportunities for lending. If the demand for bank loans is high, the demand for borrowing at the discount window will be high. An increase in the discount rate will not have the desired effect of reducing reserves, if banks can lend the new reserves at a substantial premium.

  3. Changes in the discount rate may create balance-of-payments problems. The discount rate generally sets the base for all interest rates in the country. If the discount rate is too low, money may flow out of the country in search of higher returns abroad. This outflow of money defeats the purpose of lowering the rate to expand the domestic money supply. If the rate is too high, money may flow into the country. This inflow of money defeats the purpose of raising the rate to contract the domestic money supply. Moreover, the consequent increase in the demand for dollars to buy the higher interest-bearing U.S. assets will worsen the trade balance.
Additional problems with using the discount rate are:
  1. Finding the appropriate level for the discount rate The Fed can be the cause of imbalances, if the discount rate is too high or too low for the current economic conditions. This criticism was more relevant when open market operations were not a significant tool of monetary policy. However, since the discount rate is generally tied to the federal funds rate (the target of open market operations), this criticism would justifiably hold for the federal funds rate as well.

  2. The gap between the discount rate and the T-bill rate The Federal Reserve was designed to be a lender of last resort and not a cheap source of borrowing to support bank investment portfolios or speculation in T-bills. If the discount rate is above the T-bill rate, banks will readily sell T-bills to raise reserves. However, if the discount rate is below the T-bill rate, banks would prefer to borrow at the discount window rather than sell T-bills to raise reserves. The Fed must consistently monitor bank borrowing to ensure against the window's use for carrying securities and speculation. It has been often suggested that to avoid banks' use of the discount window to support securities activities the discount rate be tied to the T-bill rate and that it set slightly above — 1/8 to 1/4% — the T-bill rate. While this would discourage use of the window for securities activities, such a "golden rule" would limit the usefulness of the discount rate as a tool of monetary policy.

  3. The gap between the discount rate and the federal funds rate Prior to January 2003, the discount rate was set 25-100 basis points below the target for the federal funds rate. For example, in December 2002, the federal funds target was 1.25% and the discount rate was .75%. The lower discount rate allowed depository institutions to borrow reserves at the lower discount rate and then lend these reserves at the higher federal funds rate. Total reserves always consisted of nonborrowed reserves which are added to the banking system through open market operations and borrowed reserves. In assessing how many securities to buy and sell to achieve a specific federal funds target, the Manager of SOMA had to guess at how many reserves would be borrowed by depository institution. In January 2003, the Federal Reserve changed its discount lending programs. Discount rate policy was changed to set the discount rate 100 basis points above the federal funds target rate. For example, in January 2003, the target for the federal funds rate was 1.0% and the discount rate was set at 2.0%. When the discount rate is above the federal funds rate, depository institutions have much less incentive to borrow reserves at the discount windows, except in an extreme emergency. Instead, they will borrow reserves in the federal funds market at the lower federal funds rate. As a result, the Manager of SOMA has much better control over total reserves, because the only reserves in the banking system are the nonborrowed reserves supplied through open market operations conducted by the Manager of SOMA. This change in discount rate policy should give the Federal Reserve much better control over money supply and interest rates.
Borrowing at the discount window is considered a privilege, not a right. Amounts and frequency of borrowing by depository institutions is closely monitored. If an institution seeks credit too often, district bank officials will discuss the matter with officers and directors of the offending institution to determine the underlying cause and to urge them to remedy their liquidity situation. In the limit, the Fed has the power to eject and replace bank management.

Because of its weaknesses and the alternative of using open market operations to change reserves on a short-term basis, the discount rate is viewed as an intermediate-term tool. Even though it may be changed as often as every two weeks, historically it has been changed, on average, only twice a year.

The discount window sets an upper bound on overnight interest rates, Robert E. Wright and Vincenzo Quadrini, Money and Banking

Quantitative Easing

Quantitative easing is economists' jargon to describe the Federal Reserve's massive injections of reserves into the banking system from purchases of all types of securities and the making of various types of loans. It includes the Term Auction Facility, the Primary Dealer Credit Facility, loans to banks to facilitiate purchases of commercial paper and asset backed securities, loans to banks to salvage failing financial institutions, and loans directly to private sector companies.

Variable Rate Loans and the Term Auction Facility

The Term Auction Facility (TAF) is a credit facility that makes collateralized loans of a predetermined fixed amount of reserves directly and anonymously to depository institutions at a competitive interest rate. The arrangement is a term repurchase agreement for a longer-term fixed period of time, e.g., 28 days or more, rather than overnight, as at the primary credit facility (PCF). At the end of the term, the transaction automatically unwinds. The collateral which may be pledged for TAF loans is the same as the collateral which may be pledged for PCF loans.

TAF is a hybrid with similarities and differences to the PCF. The TAF is similar to the PCF, in that it lends reserves to depository institutions. The TAF is different from the PCF, in that it offers a fixed volume of reserves at a variable interest rate (auction rate), whereas the PCF offers a variable amount of reserves at a fixed interest rate (primary credit rate).

The advantage of the TAF over the PCF is that the TAF process eliminates much of the stigma associated with borrowing from the PCF. When a bank borrows from the PCF, it is required to fill out all sorts of forms and explain why it needs to borrow the reserves. With the TAF, the Federal Reserve makes the reserves available unconditionally and anyone can bid anonymously. The Federal Reserve does not know which banks are borrowing until the bidding is completed.

COMPARING TAF TO PCF LOANS

The TAF is also similar to an OMO repurchase agreement, except that TAF is conducted with depository institutions while OMO are conducted with primary dealers and the TAF is conducted against a much broader range of collateral than is accepted in a standard OMO transaction. Also, with OMO, the Manager of SOMA buys and sells a variable amount of securities to achieve a particular target for the federal funds rate. With TAF, the Manager of SOMA buys and sells a fixed amount of securities and the interest rate varies, based on competitive bidding.

TAF lending is at the discretion of the Manager of SOMA. The Manager of SOMA determines the amount of reserves for auction and the banks bid competitively for the interest rate they will pay for the borrowed reserves. Lending and reserve creation is at the discretion of the Manager of SOMA. The Manager of SOMA knows precisely how many reserves the banks will borrow when assessing how many securities to buy or sell to adjust reserve positions to meet the target for the federal funds rate.

The TAF was created on December 12, 2007 to increase liquidity in the banking system and to prevent a credit crunch from the emerging subprime mortgage crisis. Since TAF's inception, the Manager of SOMA has held two auctions per month. The size of the reserve pool for auction has varied from $20 billion to $75 billion. The maturities of the TAF loans have varied from 28 to 35 days. The TAF was conceived as a temporary measure to ensure market liquidity. However, the Federal Reserve is considering to make it a permanent tool of monetary policy. Press Release, FRB BOG, 12 Dec 2007
Extensions of Credit by Federal Reserve Banks, Regulation A, FRB BOG
Another Window: The Term Auction Facility, David C. Wheelock, Monetary Trends (FRBStL), Mar 2008.
Lending to depository institutions, FRB BOG, updated as of 2 Apr 2009. Click here for Primary Discount Facility.
Alternative Instruments for Open Market and Discount Window Operations, FRS BOG, Dec 2002

Special Loans to Commercial Banks

Maiden Lane LLC

Maiden Lane LLC is a limited liability holding company that was created to bail out non-bank companies. It has been funded on several occasions by the Federal Reserve Bank of New York to facilitate these bailouts. Maiden Lane I made loans to JP Morgan Chase to buy the assets of Bear Stearns.

Press Release, FRB BOG, 3 Jul 2008
Support for specific institutions, FRB BOG, updated as of 29 April 2009

Citibank Lending

Press Release, FRB BOG, Nov 2008
Support for specific institutions, FRB BOG, updated as of 29 April 2009

Bank of America Lending

Press Release, FRB BOG, 15 Jan 2009
Support for specific institutions, FRB BOG, updated as of 29 April 2009

Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility

The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) is a lending facility that provides funding to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper (ABCP) from money market mutual funds under certain conditions. The program is intended to assist money funds that hold such paper in meeting demands for redemptions by investors and to foster liquidity in the ABCP market and money markets more generally.

In conjunction with the AMLF, the Federal Reserve Board also announced an initiative to extend non-recourse loans at the primary credit rate to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper (ABCP) from money market mutual funds. This should assist money funds that hold such paper in meeting demands for redemptions by investors and foster liquidity in the ABCP markets and broader money markets. Press Release, FRB BOG, 19 Sep 2008
Press Release, FRB BOG, 2 Dec 2008

Loans to Non-Bank Companies

The Federal Reserve can make loans directly to non-bank institutions under an obscure provision in its enabling statute [Federal Reserve Act, Sec. 13(3)], :
"In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.
Primary Dealer Credit Facility

The Primary Dealer Credit Facility (PDCF) is a credit facility that makes collateralized loans of money to non-bank primary dealers at a fixed rate of interest. The borrowing is overnight, but is renewable for up to 120 days, subject to a frequency-based fee after 30 days of use within the first 120 business days of the program. The current interest rate is equal to the primary credit rate at the Federal Reserve Bank of New York. Eligible collateral consists of a broad range of securities beyond eligible securities, including all investment-grade corporate securities, municipal securities, mortgage-backed securities, and asset-backed securities for which a price is available.

The PDCF is similar to the primary credit facility (PCF), except that the PCF services depository institutions and the PDCF services primary dealers who are not depository institutions. Previously, only depository institutions had the ability to borrow from the Federal Reserve (through the district bank PCFs). Now, the PDCF authorizes primary dealers who are not depository institutions to borrow from the Federal Reserve. Also, the PDCF accepts a broader range of acceptable collateral than is acceptable at the PCF.

Borrowing at the PDCF is at the discretion of the primary dealers. PDCF loans increase the amount of total reserves in the banking system, in much the same way that primary credit loans do. Therefore, the Manager of SOMA must closely monitor borrowings when conducting OMO with an eye to achieving a specific target for the federal funds rate.

The PDCF was created on March 16, 2008 to provide financing to participants in securitization markets and to promote the orderly functioning of financial markets more generally. The PDCF was conceived as a temporary (6 month) measure to ensure market liquidity. Nothing has been said yet about extending it or about making it a permanent institution.

On Sunday, September 14, 2008, as the 2008 financial crisis worsened and Lehman Brothers, Merrill Lynch, and AIG teetered on the verge of collapse, the Federal Reserve announced that it would expand the types of securities that investment banks could pledge as collateral for their loans from the Fed. The pool of acceptable securities was expanded to include equities, junk bonds, subprime mortgage-backed securities, and even whole mortgages. This list closely matches that of the "tri-party" overnight lending facilities run by two major clearing banks — JPMorgan Chase and Bank of New York. Those programs allow about 15% of their collateral to be pledged in equities or debt that is below investment-grade, and most of that is reserved for equities. Press Release, FRB BOG, 14 Sep 2008
Press Release, FRB BOG, 2 Dec 2008
Lending to primary dealers, FRB BOG, updated as of 2 Apr 2009. Click here for Securities Lending Facility

American International Group

The Federal Reserve made a direct loan in the sum of $85 billion to American International Group (AIG), currently, the largest American insurance company. It subsequently increased the loan to $140 billion. The collateral for the loan is ownership in AIG. The Federal Reserve received a 79.9% stake in the insurance giant.

Press Release, FRB BOG, 16 Sep 2008
Support for specific institutions, FRB BOG, updated as of 29 April 2009

Maiden Lane II and III

Maiden Lane II was funded to purchase of residential mortgage-backed securities (RMBS) from AIG. Maiden Lane II was authorized to buy and manage those assets through time to maximize repayment of the credit extended and to minimize disruption to financial markets.

Maiden Lane III was funded to purchase of certain multi-sector collateralized debt obligations (CDOs) from certain counterparties of AIG. Maiden Lane III was authorized to buy and manage those assets through time to maximize repayment of the credit extended and to minimize disruption to financial markets.

Summary of lending facilities, FRB BOG, updated as of 24 Apr 2009

Qualitative Easing

Qualitative easing, sometimes called "credit easing," is economists' jargon to describe the Federal Reserve's massive purchases of non-T-bill securities. It includes purchases of T-notes and T-bonds as well as agency and mortgage-backed securities and commercial paper as well as purchases of longer-term securities with the interest earned on short-term securities. Qualitative easing rearranges the composition of assets on the Federal Reserve's balance sheet without increasing bank reserves or creating inflationary pressures with additional money supply creation.

Operation Twist

Operation Twist is a play on words. The policy originated in 1961 at the same time baby boomers were dancing to "The Twist." The Federal Reserve determined that reducing interest rates was insufficient to stimulate a slowing economy after a downturn in 1960 and it wanted to flatten the yield curve to bring down long-term interest rates (to reduce the spread between the long-term and short-term interest rates) without necessarily increasing the money supply. The Fed "twisted" monetary policy by selling short-term government securities (with 3 years or less to maturity) that it had purchased as part of its typical quantitative easing open market policy and used the proceeds to purchase longer-term government securities (with 6 years or more to maturity). The sale of short-term securities increases supply, pulls down prices, and raises short-term interest rates while the purchase of longer-term securities increases demand, pulls up prices, and pushes down longer-term interest rates.

In March 2009, the Federal Reserve embarked on a massive qualitative easing program, whereby the Manager of SOMA bought $1.7 trillion in non-T-bill securities. The program ended a year later in March 2010. However, with continued weakness in the economy (Fall 2010) and the failure of long-term rates to fall, the Federal Reserve revived Operation Twist in September 2011. After its September 21, 2011 meeting, the Federal Open Market Committee (FOMC) announced that it would sell government securities with maturities less than 3 years and purchase $400 billion of government securities with maturities of 6 to 30 years, thereby extending the average maturity of the Fed's own portfolio.

GSE Discount Note Purchase Program

Under the GSE Discount Note Purchase Program, the Federal Reserve purchased from primary dealers federal agency discount notes, which are short-term debt obligations issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.

Press Release, FRB BOG, 19 Sep 2008

GSE Mortgage-Backed Security Purchase Program

Under the GSE Mortgage-Backed Security Purchase Program, the Federal Reserve purchased the direct obligations of housing-related government-sponsored enterprises (GSEs) — Fannie Mae, Freddie Mac, and the Federal Home Loan Banks — and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Spreads of rates on GSE debt and on GSE-guaranteed mortgages have widened appreciably of late. The Fed's action was taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally. Commercial Paper Funding Facility

Under the Commercial Paper Funding Facility (CPFF), the Federal Reserve purchased highly-rated unsecured and asset-backed commercial paper from eligible issuers via eligible primary dealers. Press Release, FRB BOG, 25 Nov 2008
Press Release, FRB BOG, 30 Dec 2008

Liquidity Facilities

A liquidity facility is different from a credit facility. A credit facility lends in a way that creates new reserves for the banking system. A liquidity facility simply increases the liquidity of the assets held by the private sector. It does not increase bank reserves. The liquidity facility lends more liquid securities for less liquidity securities. It is similar to a temporary swap of more liquid securities for less liquid securities.

Term Securities Lending Facility

The Term Securities Lending Facility (TSLF) is a credit facility that makes collateralized loans of a predetermined fixed amount of high quality, liquid Treasury securities directly and anonymously to primary dealers in exchange for lower quality, less liquid securities (collateral) at a competitive interest rate. The arrangement is a term repurchase agreement for a longer-term fixed period of time, e.g., 28 days or more, rather than overnight, as in the existing program. At the end of the term, the transaction automatically unwinds. The collateral which may be pledged for the Treasury securities consists of all collateral currently eligible for tri-party repurchase agreements arranged by the Manager of SOMA, other AAA/Aaa-rated private-label residential mortgage-backed securities (MBS), commercial MBS, agency collateralized-mortgage obligations (CMO), and other asset-backed securities (ABS), excluding collateralized debt obligations (CDO), collateralized loan obligations (CLO), and collateralized bond obligations (CBO).

The TSLF is similar to the TAF, except that the TAF is a bi-weekly competitive auction of reserves for depository institutions (whether or not they are primary dealers) who pledge discount window collateral, whereas the TSLF is a weekly competitive auction of Treasury securities for all primary dealers (whether or not they are depository institutions) who pledge other program-eligible securities.

TSLF lending is at the discretion of the Manager of SOMA. The Manager of SOMA determines the amount of Treasury securities for auction and the composition of the pool and the primary dealers bid competitively for the interest rate they will pay for the borrowed securities. The Manager of SOMA knows precisely the volume of total reserves when assessing how many securities to buy or sell for OMO, because the TSLF does not change the amount of total reserves in the banking system. Rather, it increases the liquidity of primary dealers by giving them more higher quality, more liquid Treasury securities in exchange for lower quality, less liquid collateralized debt obligations (CDOs).

The TSLF was created on March 11, 2008 to supplement the Term Auction Facility (TSLF) that was opened in December 2007. Its purpose is to increase liquidity in the financial system and to prevent contagion in the financial markets from defaults on subprime mortgages and the collapse of a major investment bank, The Bear Stearns Companies, Inc. Since its inception, the size of the weekly TSLF offerings has varied from $20 billion to $75 billion. The Federal Reserve expects to lend up to $200 billion of Treasury securities to primary dealers.

On Sunday, September 14, 2008, as the 2008 financial crisis worsened and Lehman Brothers, Merrill Lynch, and AIG teetered on the verge of collapse, the Federal Reserve announced that it would expand the types of securities that investment banks could pledge as collateral for their securities swaps. Eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities.

In addition, Schedule 2 TSLF auctions will be conducted each week and the offer amounts will be increased to a total of $150 billion, from a total of $125 billion. Amounts offered in Schedule 1 auctions will remain at a total of $50 billion. Thus, the total amount offered in the TSLF program will rise to $200 billion from $175 billion. Press Release, FRB BOG, 11 Mar 2008
Press Release, FRB BOG, 14 Sep 2008
Press Release, FRB BOG, 2 Dec 2008
Lending to primary dealers, FRB BOG, updated as of 2 Apr 2009. Click here for Primary Dealer Credit Facility

Term Asset-Backed Securities Loan Facility

The Term Asset-Backed Securities Loan Facility (TALF), is a liquidity facility that will help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).

Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans. The FRBNY will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS. The U.S. Treasury Department — under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008 — will provide $20 billion of credit protection to the FRBNY in connection with the TALF.

New issuance of ABS declined precipitously in September and came to a halt in October. At the same time, interest rate spreads on AAA-rated tranches of ABS soared to levels well outside the range of historical experience, reflecting unusually high risk premiums. The ABS markets historically have funded a substantial share of consumer credit and SBA-guaranteed small business loans. Continued disruption of these markets could significantly limit the availability of credit to households and small businesses and thereby contribute to further weakening of U.S. economic activity. The TALF is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more normal interest rate spreads. Press Release, FRB BOG, 25 Nov 2008

Swap Lines

Swap lines are reciprocal currency arrangements with foreign central banks. They are intended to unfreeze illiquid money markets that became segmented across counties and time zones.

< b> Press Release, FRB BOG, 12 Dec 2007
Central bank liquidity swaps, FRB BOG, updated as of 28 Apr 2009

Summary of Federal Reserve Liquidity Operations, Credit Facilities, and Special Arrangements

Traditional Facilities
    OMOs — Open market operations: repos against U.S. government securities and outright holdings of U.S. government securities
    PCF — Primary Credit Facility; traditional discount window
    SL — overnight securities lending facility; bonds for bonds
New Arrangements (month of announcement) The above operations, facilities, and arrangements can be cross-classified as backstop lending or auction facilities for depository institutions, primary dealers, or others. The big difference between the backstop lending facilities and auction facilities is the anonymity of the borrower. At the backstop lending facilities, the borrower presents itself, hat in hand. At the auction facilities, the bidding for a fixed amount is anonymous.

TAXONOMY OF FEDERAL RESERVE LIQUIDITY OPERATIONS,
CREDIT FACILITIES, AND SPECIAL ARRANGEMENTS
Depository Institutions Primary Dealers Others

Backstop
Lending
Facilities
< /td>
Primary Credit Facility
(Discount Widow)
(PCF)
Primary Dealer
Credit Facility
(PDCF)
Lending pursuant to
Section 13(3) of the
Federal Reserve Act
swap lines, Maiden Lane, AIG, AMLF, CPFF, MMIFF, TALF

Auction
Facilities
Term Auction Facility
(TAF)
Term Securities
Lending Facility
(TSLF)

All Credit and Lending Facilities

Collateral and rate setting, FRB BOG, updated as of 9 May 2009
Risk management, FRB BOG, updated as of 2 Apr 2009
Longer-term issues, FRB BOG, updated as of 23 Feb 2009
Congressional reports and other resources, FRB BOG, updated as of 10 Jun 2009

Reserve Deposit Management

Reserve Requirements

CHANGES IN RESERVE REQUIREMENTS
fedfndsmkt
When reserve requirements are raised (lowered), banks excess reserves decrease (increase). The demand for reserves (Rd) increases (decreases) and the federal funds rate (iff) rises (falls).
Reserve requirements are percentages that set the fraction of deposit liabilities the banks must have on hand in the form of acceptable reserves. Originally, reserve requirements were imposed to maintain liquidity in the banking system. They were designed to ensure that banks had sufficient cash (or specie) to pay out on demand to their depositors. However, by their very nature, required reserves are unavailable to be paid out. Therefore, banks must have excess reserves on hand to meet depositors' withdrawal needs.

Today, the function of the reserve requirements is to control indirectly the amount of money supply which can be created by the banks through their lending processes. If the percentage is zero, then no reserves are required and banks can extend credit, create deposits, and expand the money supply ad infinitum. Only sound lending policies will prevent excessive money creation and liquidity problems. If the percentage is 100%, then the banks must hold all of their deposits in the form of reserves and no money supply expansion can take place. The money supply will consist solely of monetary base. If the percentage is somewhere between 0% and 100%, banks are required to keep some fraction of deposits in reserves, but are free to lend out any excess reserves. This "fractional reserve" system permits some credit extension, but sets an upper limit to credit creation, deposits liabilities, and the money supply.

The three types of reserve requirements are:
  1. Basic reserve requirements against traditional deposits—demand and savings accounts (Regulation D)

  2. Marginal reserve requirements against large negotiable CDs and bank-related commercial paper (Regulation D)

  3. Reserve requirements governing foreign activities of U.S. banks (Regulations A, D, and N).
Demand deposits
Central reserve city banks13-26%
Reserve city banks10-20%
Country banks7-14%
Time deposits
All banks3-6%
Early in the history of the Federal Reserve System, reserve requirements for demand deposits at member banks were fixed at 13% for central reserve city banks (New York and Chicago), 10% for reserve city banks, and 7% for banks in all other cities (country banks), and at 3% for time deposits in all banks. These requirements remained unchanged until the Great Depression. In 1933, the Fed was given emergency authority, subject to the approval of the President, to vary these requirements.

The Banking Act of 1935 made the reserve requirement a permanent instrument of control by the Federal Reserve and eliminated the President's approval. The actual reserve requirements were set between 7% for net demand deposits up to $2 million and 16.25% for net demand deposits in excess of $400 million. In 1974, the Fed decided to vary the reserve requirement on time deposits by maturity, reducing the requirement as maturity lengthened.

In 1969, the Fed extended requirements to foreign activities — deposits due from domestic banks to foreign branches, deposits lent to U.S. banks by foreigners, and borrowings from unrelated banks abroad. In 1973 and 1975, reserve requirements on borrowing from foreign banks were cut sharply to improve the position of the dollar, and effective August 24, 1978, these requirements were dropped from 4%, 1%, and 4%, respectively to 0%. Also, managed liabilities — large time deposits, Eurodollar borrowings, repurchase agreements against U.S. government and federal agency securities, federal funds borrowings from nonmember institutions, and certain other obligations — have been subject to reserve requirements. Starting with the reserve maintenance period for October 25, 1979, a marginal reserve requirement of 8% was levied against managed liabilities above $100 million. The marginal requirement was raised to 10% beginning April 3, 1980, decreased to 5% beginning June 12, 1980, and eliminated beginning July 24, 1980.

The Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) changed the whole structure of reserve requirements.
  • DIDMCA reclassified deposit types New types of deposits, especially checkable interest-bearing accounts, blurred the old distinction between demand and time deposits. The Fed reclassified deposit accounts as transaction accounts, personal time deposits, non-personal time deposits, and Eurodollar liabilities.

    • Transaction accounts include all deposits on which the account holder is permitted to make withdrawals by negotiable or transferable instruments, payment orders of withdrawal, and telephone and pre-authorized transfers (in excess of three per month) for the purpose of making payments to third persons others.

      Personal time deposits, including savings deposits, are all time accounts held by natural persons.

      Non-personal time deposits, including savings deposits, are those held by depositors that are not natural persons—corporations institutions, governments, etc.

      Eurodollar liabilities include all dollar-denominated borrowings by U.S. banks from foreign banks holding dollars.

  • DIDMCA simplified the structure of reserve requirements At the same time, the structure of reserve requirements was significantly simplified to only two marginal requirements against transaction accounts and non-personal time accounts. DIDMCA requires that the amount of transaction accounts against which the 3% reserve requirement applies be modified annually, as of June 30, by 80% of the percentage increase in transaction accounts held by all depository institutions.

  • DIDMCA lowered reserve requirements The marginal rate for transaction accounts (now 10%) may be varied between 8% and 14%. Reserve requirements were eliminated for all personal time deposits and for non-personal time deposits with maturities of 2.5 years or more. On non-personal time deposits with maturities less than 2.5 years, the requirement (now 3%) can be varied between 0% and 9%.

  • DIDMCA extended the Fed's authority to include nonmember banks and thrift institutions.
The impact or effectiveness of reserve requirements are:
  1. Basic reserve requirements affect the size of the money multiplier. Given any monetary base (B), the higher the reserve requirements, the smaller the multiplier (m) and the smaller the money supply (Ms). As the reserve requirement is raised, banks must set aside a larger percentage of each deposit, leaving less excess reserves for lending. With less lending, the money supply is contracted. The lower the reserve requirements are, the larger the multiplier and the money supply are. As the reserve requirement is lowered, banks can set aside a smaller percentage of each deposit, leaving more excess reserves for lending. With more lending, the money supply is expanded.

  2. Marginal reserve requirements and reserve requirements against foreign activity can be used to influence the availability of funds or liquidity of banks. Changes in these requirements can affect the amount of total reserves in the banking system. When these requirements are lowered, banks can increase their liquidity and reserves more easily by issuing large negotiable CDs and commercial paper, or by borrowing from abroad. These activities increase total reserves for the banking system. When these requirements are raised, bank liquidity and reserves are reduced because issuing large negotiable CDs and commercial paper or borrowing from abroad becomes more expensive. These activities reduces total reserves for the banking system.
The reserve requirements have certain strengths and weaknesses. The strengths of reserve requirements are:
  1. Changing reserve requirements is the most powerful tool available to the Federal Reserve. A small 1% change in reserve requirements affects billions of dollars in reserves. For this reason, any proposed increase must be announced two weeks prior to its implementation to allow banks to adjust their reserve positions.

  2. Changes in reserve requirements affect all banks and do so directly and immediately. In contrast to open market operations, which are concentrated in a few banks and whose impact is then gradually transmitted to the rest of the banking system, and to changes in the discount rate, which affect only borrowers at the discount window, changes in reserve requirements affect all banks equally.

  3. Imposition of reserve requirements is available to all economies at all times. They can be used when securities markets in developed countries are not functioning properly and they can be used in lieu of open market operations in countries where securities markets are not sufficiently developed to permit successful open market operations.
The weaknesses of reserve requirements are:
  1. Reserve requirements are a clumsy instrument of control. Because a small 1% change in reserve requirements affects billions of dollars in reserves, requirements cannot be changed frequently. To do so would wreak havoc on the banks deposits and loan portfolios. Generally, reserve requirements are used to represent the structural (long-term) stance of monetary policy and are changed infrequently. When they are changed, banks view the change in the reserve position as permanent and tend to adjust their long-term assets accordingly.

  2. An increase could embarrass banks that are not sufficiently liquid and cannot meet easily the higher reserve requirements. Although banks are given a two-week adjustment period when requirements are to be raised, some may not be able to adjust so quickly.

  3. Changes in reserve requirements hamper monetary control over short periods. Because reserve requirements affect the money multiplier, any change creates instability in the multiplier. With an unstable money multiplier, control of the money supply (through control of the monetary base-open market operations) is lost.
Although changes in reserve requirements can be used as a counter-cyclical tool, and important reductions in legal ratios were made in years of economic slack-1953-54, 1958, 1970, 1974, and 1980, the Fed has been reluctant to lower them during periods of slack, because they would have to raise them during periods of prosperity. Bankers would prefer that the Fed lower requirements as a stimulatory tool because lower reserve requirements increase the percentage of assets of banks earning income and improve the banks international competitive position. The U.S. Treasury, however, would prefer open market purchases which reduce interest rates directly and lower the cost of the national debt. In general, reserve requirements have trended downward over the years.

Interest on Reserve Deposits

Paying interest on reserve balances allows the Federal Reserve to divorce interest rate policy from liquidity policy. It can change the federal funds rate without changing the amount of reserves in the banking system and it can buy as many securities or make as many loans as it wants and not affect the federal funds rate.

FEDERAL FUNDS MARKET
fedfundsmkt fedfundsmkt
If the Federal Reserve pays NO interest on reserves, the demand for reserves (Rd) is downward sloping and represents the banks' demand to support deposits from they do not demand reserves to lend, but rather they demand reserves to hold at the reserve balances interest rate. However, if the Federal Reserve pays interest on reserve balances (ir), then, the demand becomes perfectly elastic at the reserve balances interest rate. When the Federal Reserve raises (lowers) the reserve balances interest rate (ir), the demand for reserves (Rd) shifts up (down) horizontally.
fedfundsmkt fedfundsmkt
When the Federal Reserve sets the discount rate (id) above the federal funds rate (iff) and also pays interest on reserves (ir), it "collars" the federal funds rate between the two rates. The Manager of SOMA can now buy T-bills and simultaneously flood the banks with nonborrowed reserves and the federal funds rate will not drop below the reserve balances interest rate (points 1 to 2 to 3). If the Federal Reserve wants to raise the federal funds rate (iff), it has several options, depending on how much liquidity it wants to keep in the banking system. If it wants to raise the federal funds rate and mop up liquidity, it sells T-bills and decreases nonborrowed reserves (points 1 to 2 to 3). If it wants to raise the federal funds rate, but leave reserves in the banking system, it simply raises the reserve balances interest rate (points 1 to 4).

Interest on Reserves and Monetary Policy, Marvin Goodfriend Economic Policy Review (FRBNY), May, 2002: 13-29; Proceedings of a Conference Sponsored by the FRBNY, April 5-6, 2001 (includes diagram of demand for reserves with interest payments)
Divorcing Money from Monetary Policy, Todd Keister, Antoine Martin, and James McAndrews, Economic Policy Review (FRBNY), Sep 2008: 41-56
The Effect of Interest on Reserves on Monetary Policy, John R.Walter and Renee Courtois, Economic Brief (FRBRich), EB09-12, Dec 2009
FAQs about Interest on Reserves and the Implementation of Monetary Policy, FRBNY
Interest on Required Balances and Excess Balances, FRB BOG, current data, 3Q10
Interest on Required Reserve Balances and Excess Balances FAQs, FRB BOG, last updated, 27 May 2010
Paying interest on reserves puts a floor under the overnight interest rate, Robert E. Wright and Vincenzo Quadrini, Money and Banking
Monetary Policy in a World with Interest on Reserves, Charles T. Carlstrom and Timothy S. Fuerst, Economic Commentary (FRBClev), 10 Jun 2010
Press Release, FRB BOG, 6 Oct 2008

Selective Monetary Policy Controls

Selective controls are the discriminatory tools of monetary policy. They include interest rate controls, credit controls, and jawboning. Selective controls are considered to be selective, because they are applied to specific economic participants or specific markets. They are designed to target a particular credit problem. However, even selective controls may be non-discriminatory in that other economic and financial sectors may be affected by particular controls. For example, consumer or mortgage credit controls that restrict household borrowing may leave banks with excess reserves at going interest rates. In order to lend these excess reserves to businesses, the banks may lower interest rates. Similarly, the financial markets are heavily influenced by changes in margin requirements. If higher margin requirements make leveraged securities purchases less attractive, people may use their money to buy real goods and services. If lower margin requirements make leveraged securities purchases more attractive, people may buy less real goods and services.

Interest Rate Controls on Deposits

Interest rate controls on deposits are the maximum rates banks can pay on deposit liabilities (Regulation Q). Regulation Q was not initially intended as a stabilization tool. Originally, the ceilings were intended to curb competition among banks. It was believed that competition for deposits had raised bank costs, encouraged investment in high risk assets to cover deposit interest costs, weakened the banking system, and led to the large number of bank failures during the Great Depression. Subsequently, they were used to influence the flow of funds to various credit markets. On savings deposits, for example, ceiling rates for thrift institutions were set 0.25% above the ceiling rates for commercial banks to attract funds to the residential real estate market.

As a tool of monetary policy, raising interest rate ceilings on deposits has the effect of intermediation-the increased flow of funds into depository institutions-and of influencing other interest rates and the availability of total credit. The more funds flow through depository institutions, the greater control the Fed has on the money supply. So long as ceiling rates are in line with money market rates, they can be used to subtly influence the flow of funds among credit markets. However, if they are substantially below market rates, then disintermediation — the outflow of funds from depository institutions directly into the credit markets — will place depository institutions at a disadvantage, creating liquidity problems, credit crunches, and discriminatory lending in specific markets. Controls distort the pattern of the flow of funds. As of April 1986, after a six-year phase-out period under DIDMCA, all interest rate ceilings at depository institutions had been eliminated.

Consumer Credit Controls

Consumer credit controls set the minimum downpayment, maximum repayment period, and sometimes the interest rates charged on consumer purchases (formerly, Regulation W). The larger the minimum downpayment, the shorter the repayment period, and the higher the interest rate, the more difficult it is for consumers to finance new purchases; hence, the less spending in the economy. The smaller the downpayment, the longer the repayment period, and the lower the interest rate, the easier it is for consumers to finance new purchases; hence, the more spending in the economy.

As a stabilization tool, consumer credit controls influence directly the purchase of consumer goods, especially durables, and indirectly the rest of the economy. If they are relaxed, bank lending increases and the money supply is expanded, as a consequence. If they are tightened, bank lending is reduced, the money supply contracts, more spending generates more income and less spending produces less income.

The main reason for imposing consumer credit controls is to smooth out the flow of consumer spending to keep the economy from inflating. Most credit controls have been imposed during wartime. However, the last time the Fed imposed consumer credit controls was in 1980. On March 14, 1980, with the inflation rate still rising, the FOMC, at the direction of Chairman Paul Volcker, imposed credit controls. Credit card use was curtailed and other forms of consumer borrowing were discouraged. The restrictions worked. Inflation began to fall, but a recession developed. In the summer of 1980, most of the credit controls were scrapped. Currently, the Fed maintains no consumer credit controls.

Mortgage Credit Controls

Mortgage credit controls set the minimum downpayment and maximum repayment period on residential mortgages (formerly, Regulation X). The larger the minimum downpayment and the shorter the repayment period, the more difficult it is for buyers to finance new homes; hence, the less spending in the economy. The smaller the minimum downpayment and the longer the repayment period, the easier it is for buyers to finance new homes; hence, the more spending in the economy.

As a stabilization tool, mortgage credit controls influence directly the purchase of real estate and indirectly the rest of the economy. If they are relaxed, bank lending increases and the money supply is expanded. If they are tightened, bank lending is reduced and the money supply contracts. If they are relaxed, more spending generates more income. If they are tightened, less spending produces less income.

The main reason for imposing mortgage credit controls is to smooth out the flow of consumer spending to keep the economy from inflating. Among all of the selective controls, mortgage credit controls have had the shortest life. They were imposed in 1950 at the start of the Korean conflict and suspended in 1952. The Fed no longer maintains mortgage credit controls.

Margin Requirements

Margin requirements set the minimum downpayment on securities purchases (Regulations T, U, and X). The Fed may set this requirement between 50%-100% on equity securities (stocks). Margin stocks, for which the regulatory limitations apply, are all corporate stocks registered on the national exchanges plus selected NASDAQ stocks. Regulations apply also to convertible bonds and short sales. If the price of a security declines after the loan is made, the law does not require the borrower either to put up additional collateral or to reduce his indebtedness. But the lender, on his own, may require additional collateral. Common maintenance requirements at the major brokerage houses are 30%-35%.

The main reason for imposing margin controls is to reduce fluctuations in stock prices caused by the extension of unregulated credit for securities purchases. As stabilization tool, however, margin requirements have broader effects. The higher the requirement, the more difficult it is to buy securities; the lower the requirement, the easier it is to buy securities. By the same token, the higher (lower) the requirement, the more difficult (easy) it is for firms to obtain financing for capital improvements. As margin requirements are lowered, the demand for securities increases and securities prices rise. Capital gains, whether realized or only on paper, have the effect of inducing consumption through the wealth effect. As margin requirements are raised, the demand for securities decreases and securities prices fall. Capital losses, whether realized or only on paper, have the effect of reducing consumption through the wealth effect.

Jawboning

Jawboning (moral suasion) is verbal pressure on the banks and other financial institutions to ensure compliance with monetary goals. Paul Volcker, a former Chair of the Fed, used verbal pressure on business and labor to keep prices and wages down. He applied verbal pressure on the banks to refinance the Third World debt. He jawboned the Administration and Congress continually to reduce the federal budget deficit. Actually, jawboning is a pressure technique used by all of the policy-making bodies. President Reagan put verbal pressure on the Federal Reserve and the banks to lower interest rates. Through out the 1980s, the President, the Congress, and Mr. Volcker tried to "talk" down the foreign exchange value of the dollar. And, ever since his appointment as the Fed's Chair, in 1987, Alan Greenspan has been jawboning the Congress into reducing the federal budget deficit. It finally worked!!!

Exit Strategy

The Fed's Exit Strategy Explained, Mark Sniderman, Forefront (FRBClev), Apr 2010

top    III. Debt Management Policies

Debt management policies involve changing the maturities on the various government security issues to influence interest rates in the different securities markets by maturity. Manipulation of the supply of securities to the different maturity markets influences the term structure of interest rates and the yield curve. By changing the term structure of interest rates, the government changes the relative attractiveness of different kinds of borrowing to influence macroeconomic activity.

Debt Instruments

The Treasury issues securities for two purposes: to finance the current annual deficit and to refund or "roll over" outstanding debt as it matures. The Treasury can make a cash offering in which buyers simply pay cash for any securities they receive, or it can make an exchange offering, whereby it offers new debt to holders of maturing issues. Since not all current holders desire to renew their lending to the federal government, portions of exchange offerings have been sold on a cash basis. Because of problems in refunding the debt with exchange offerings, the Treasury has elected to use only cash offerings since 1973.

Most Treasury securities are marketable, which means they may be traded any number of times before reaching maturity. The rest are non-marketable which means they are held by the original purchaser until maturity or redemption by the Treasury. It is the marketable debt over which the Treasury exercises the greatest measure of control and which has the greatest impact on the cost and availability of credit in the nation's financial markets.

Monthly Statement of the Public Debt, 30 Jun 2010

Marketable Securities

As of June 2010, the Treasury had issued $8.1 trillion of marketable securities. Marketable securities represents a little 61% of all interest-bearing U.S. government debt totaling $13.2 trillion. The current spectrum of maturities ranges from a few days for cash management bills to 30 years for bonds. Thus, the government has the option of borrowing short-term, medium-term, or long-term, while the average maturity of marketable debt has varied with the Treasury's selection of alternative debt instruments. The average maturity of marketable debt declined down through the mid-1970s to 2 years 5 months, but rose to 6 years 2 months in 2001. When the Treasury stopped issuing the 30-year bond in October 2001, the average maturity declined and, as of March 2004, it was only 4 years 10 months. The Treasury reintroduced the 30-year bond on February 9, 2006, and, subsequently, the average maturity on marketable debt increased.

Short-term borrowing consists of issuing T-bills in 3-, 6-, and 12-month maturities. T-bills are issued in denominations of $1,000 and up and are sold at discount with fixed coupon rate. If the yield curve is normal, then short-term financing is the least expensive; however, the shorter the term of finance, the more frequently the government must be in the market to rollover its debt. This increased frequency of borrowing may have a destabilizing effect on the financial markets. Increased borrowing in the short-term market tends to invert the yield curve as short-term rates rise above long-term rates to accommodate the increased supply of short-term debt.

Medium-term borrowing consists of issuing T-notes in 2-year to 10-year maturities. T-notes are issued in denominations of $1000, $5000, $10,000, $100,000, and $1 million and pay interest at fixed coupon rates semiannually. In 1967, the allowable maturity on notes was extended from 5 to 7 years. In 1975, Congress extended the allowable note maturity from 7 to 10 years. Increased borrowing in the medium-term market tends to give the yield curve a 5-7 year "hump" as medium-term rates rise above both short- and long-term rates to accommodate the increased supply of medium-term debt.

T-note borrowing became more important to the Treasury when interest rates rose in the 1970s. Under the Victory Liberty Loan Act of 1918 (the last of a series of Victory Liberty Loan Acts in 1917 and 1918), the Treasury was constrained to a maximum interest rate of 4.25% on T-bond issues. As long as long-term interest rates stayed below 4.25%, this interest rate ceiling posed no problem for debt management. However, in the 1960s, when long-term interest rates rose above this ceiling rate, the Treasury had to get special permission from Congress to issue T-bonds with coupon rates in excess of 4.25%. The Treasury could circumvent the bond rate restriction by issuing short- and medium-term securities (T-bills and T-notes) which carry no such restrictions. Congress eliminated the ceiling rate on marketable bonds in 1988.

Long-term borrowing consists of issuing T-bonds in 30-year maturities. T-bonds are issued in denominations of $1,000 and up and pay interest at fixed coupon rates quarterly or semiannually. Generally, with a normal yield curve, long-term financing is most expensive; however, the longer the term of finance, the less frequently the government must return to the market to rollover its debt. Long-term financing tends to be more stabilizing for the financial markets. Increased borrowing in the long-term market tends to exaggerate the normal (upward-sloping) yield curve as long-term rates rise above shorter term rates to accommodate the increased supply of long-term debt. However, in October 2001, the Treasury announced that it would suspend issuance of 30-year bonds. It reintroduced issuance of the 30-year bond on February 9, 2006.

Special Certificates of Indebtedness Except for temporary imbalances, the Treasury is not allowed to borrow directly from the Federal Reserve. When the Treasury does borrow, it issues special certificates of indebtedness, normally to the New York Federal Reserve Bank, for the amount of the loan and receives a corresponding increase in its general account. The Treasury borrows infrequently and almost exclusively to cover overdrafts on the Treasury's accounts with the Fed. Sometimes the borrowing occurs when Treasury balances are low (the second week of the month is traditionally a low point) and a large inflow of funds is expected shortly. Special certificates are issued in book-entry rather than definitive form.

In June 1979, legislation modified the conditions for using this method. Under the new legislation, the Treasury can borrow cash directly from the Fed only after the Board of Governors, by an affirmative vote, has determined that "unusual and exigent circumstances" exist. In all other circumstances, Federal Reserve assistance is limited to lending securities to the Treasury from the System portfolio. The Treasury is expected to sell the securities in the open market to obtain cash and must replace the securities within six months.

In either case, total Treasury borrowings from the Fed by law cannot exceed $5 billion. From 1957 to mid-1979 loans were made at an interest rate one-quarter of 1% (.0025) less than the discount rate at the New York Fed. That rate continues in effect if the Treasury borrows directly from the Fed rather than borrowing securities. When the Treasury borrows securities it pays interest to the Fed at an annual rate of one-eighth of 1% (.00125) below the discount rate at the New York Fed. Meanwhile, the Fed continues to earn interest on the securities lent.

Borrowings from the Fed since 1975 have been primarily limited because of three factors:
  1. At times, the Treasury's borrowing authority from the Fed lapsed or verged on lapsing. The borrowing authority must be renewed regularly by Congress.

  2. Treasury debt managers since 1975 have tended to keep larger cash balances than previous managers.

  3. The Treasury developed and has been using short-term cash management bills as an alternative to the Treasury's borrowing securities from the Fed and reselling them in the market. The same effect can be achieved, probably more efficiently, if the Treasury sells short-term cash management bills directly. These debt instruments, with maturities of up to 50 days, can be sold quickly to money market participants in minimum denominations of $1 million, or occasionally, $10 million.
Inflation-Indexed Securities In January 1997, the Treasury issued its first inflation-indexed securities. The following is a summary of the key provisions of the final rules and features of inflation-indexed securities:
  1. The inflation-indexed securities will be structured similarly to the Real Return Bonds issued by the Government of Canada.

  2. The interest rate, which is set at auction, will remain fixed throughout the term of the security.

  3. The principal amount of the security will be adjusted for inflation, but the inflation-adjusted principal will not be paid until maturity.

  4. Semiannual interest payments will be based on the inflation-adjusted principal at the time the interest is paid.

  5. The index for measuring the inflation rate will be the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U), published monthly by the Bureau of Labor Statistics (BLS).

  6. The auction process will use a single-price auction method that is the same as that currently used for 2-year and 5-year Treasury notes.

  7. The securities will be eligible for stripping into their principal and interest components in Treasury's Separate Trading of Registered Interest and Principal of Securities (STRIPS) program.

  8. At maturity, the securities will be redeemed at the greater of their inflation-adjusted principal or par amount at original issue. The payment of an additional amount at maturity, if necessary, to ensure that the inflation-adjusted principal plus the additional amount equals the par amount at original issuance is different than the minimum guarantee provision that Treasury was considering in the Advance Notice of Proposed Rulemaking.

  9. The first auction of inflation-indexed securities, a 10-year note, will be held in January 1997, and quarterly thereafter.

  10. If, while an inflation-indexed security is outstanding, the CPI is (i) discontinued, (ii) in the judgment of the Secretary, fundamentally altered in a manner materially adverse to the interests of an investor in the security, or (iii) in the judgment of the Secretary, altered by legislation or Executive Order in a manner materially adverse to the interests of an investor in the security, the Treasury, after consulting with the BLS, will substitute an appropriate alternative index.

  11. Regulations addressing the tax treatment of inflation-indexed securities were published by the IRS on January 6, 1997. Generally, the interest payments will be taxable when received, which is consistent with the tax treatment of other Treasury securities. The inflation adjustments to the principal will be taxable in the year in which such adjustments occur even though the inflation adjustments will not be paid until maturity.
Non-marketable Securities

U.S. Savings Bonds and Notes This component of government debt is sold directly to the general public in small denominations, generally through banks. Individuals may participate in a payroll savings plan, whereby a portion of their salary or wages may be withheld to purchase savings bonds each month or each pay period. Congress sets a statutory limit on the yield that may be paid on savings bonds. The volume of savings bonds increased during the 1960s and 1970s, reaching a high of almost $81 billion in 1978. Then, soaring interest rates encouraged even small savers to seek other outlets for their funds, especially money market mutual funds. By 1985 that volume had fallen to $74 billion (less than 5% of the public debt). To make savings bonds more attractive, Congress instituted a floating rate savings bond tied to the T-bill rate, with a minimum 7.5% yield when held to maturity. If redeemed prior to maturity, the rate is something less, depending on the length of the holding period. Subsequently, sales volume increased to $456 billion in March 2004, but has decreased to $189.7 billion by June 2010.

Government Account Series These securities are issued by the Treasury to the various government agencies and trust funds, including the Social Security Administration, the Rural Electrification Administration, the Tennessee Valley Authority, and several smaller government agencies. As these governmental units accumulate funds, they turn them over to the Treasury in exchange for special, non-marketable IOUs, thus reducing the federal government's borrowing activity in the open market. As of June 2010, the government account series totals $4.7 trillion or 36% of the federal government's debt.

Dollar-Denominated Foreign Issues Large foreign holdings of dollars represent a constant threat to the value of the U.S. dollar. Therefore, the Treasury periodically issues small amounts of dollar-denominated debt to sell to foreigners to attract these overseas funds.

Foreign Currency-Denominated Issues In order to increase US. government holdings of foreign currencies that can be used to settle international claims, the Treasury occasionally issues foreign currency-denominated securities to investors abroad.

State and Local Government Issues The Treasury makes special securities available to state and local governments as a temporary outlet for the funds raised by these governments when they borrow in the open market.

The Public Debt

The accumulation of all debt used to finance the annual federal budget deficits minus any retirements equals the public debt. The total amount of debt that the federal government can incur is subject to a debt ceiling legislated by Congress. The current debt limit is $14.294 trillion. Congress must legislate approval for the Treasury to issue debt beyond this limit. The statutory debt limit is logically redundant, because Congress is responsible for passing on the federal budget, which determines the annual deficit and therefore the growth in the public debt. Yet, Congress retains its control over the debt limit for political rather than economic reasons. As annual budget deficits push the public debt beyond current limits, Congress must enact higher debt limitations. In recent years, with the large federal budget deficits, Congress has had to legislate several adjustments, sometimes raising the limit on an intra-year basis.

About 34% of all debt is held by government agencies. Since this debt requires only inter-agency transfers, the debt is not considered serious and the government need not worry about rolling it over. The remaining 66% of the current $13.2 trillion debt or $8.6 trillion, however, is owned by private citizens, institutions, banks, corporations, and foreigners. The Treasury must be concerned with the public debt, plus any new deficits, when setting its debt management policies.

top    IV. Incomes Policies

Incomes policies involve rearranging the shares of income received by different classes of economic participants. By rearranging income shares, the government can influence either demand-side expansion (Keynesian) or supply-side expansion (Monetarist).

Wage and Price Controls

Absolute Controls set or "freeze" wages and prices at some absolute level.

Rate of Growth Controls set or "freeze" the annual percentage changes for wages and prices. In an inflationary period, the annual percentage increase in wages and prices is limited to some maximum rate of increase. In a deflationary period, the annual percentage decrease in wages and prices is limited to some maximum rate of decrease.

Voluntary Controls serve as benchmarks, are not legally binding on businesses, and do not have associated penalties for non-compliance. They are usually called "guidelines" or guideposts".

Mandatory Controls are legislated rules. They are legally binding on businesses and are enforced with penalties for non-compliance.

Strengths of Wage and Price Controls
  1. Their imposition immediately caps wages and prices to defuse inflationary expectations and to stop an inflationary (deflationary) wage-price spiral.

  2. Their imposition increases real income, because the only way to circumvent the caps is to work harder and longer.
Weaknesses of Wage and Price Controls
  1. They distort the pattern of resource usage.

  2. They suppress inflation, not cure it.

  3. They require yet another government agency or bureau to police economic behavior and enforce the controls.
Tax-Based Incomes Policies or Incentive Plans

Tax-Based Incomes Policies or Tax-BasedIncentive Plans (TIPs) are financial incentives or rewards to businesses for complying with wage and price controls. They are designed to persuade rather than coerce. The only penalty for non-compliance is loss of the incentive or benefit.

Indexing

Indexing is a method which allows prices to vary with market conditions, but limits factor cost increases to some fraction of the increase in prices. The theory is that cost-containment implies price-containment.

top    V. Supply Management Policies

Supply management policies consist of a combination of public production, economic planning, and regulations to direct resources around the economy. They involve heavy government intervention.

Public Production

Economic Planning

Material Balance Planning

Indicative Planning

Regulation

top    VI. Supply-Side Economic Policies

Supply-side economic policies are the antithesis of supply management policies. They attempt to eliminate government intervention in the economy. By eliminating government intervention and changing the relative prices of leisure/work and consumption/saving, supply-side economic policies attempt to increase potential output.

The Size of Government

Supply-side economists argue that only the private sector can promote long-term stable growth and full employment and that the size of government is extremely important to how well the private sector operates to achieve these goals. If government is too big, it takes too many resources and too much finance away from capacity-increasing, productive capital, which stifles individual initiative and enterprise. To achieve better performance in the private sector and improve individual initiative and enterprise, the government must reduce its absorption of resources and finances by cutting both spending and tax collections. The key to unclogging stagflation is to push out the supply curve, rather than simply increasing demand.

Government Expenditures

Supply-siders argue that, rather than being expansionary, as the Keynesians claim, excessive government spending reduces the economy's ability to grow over the long-run; and that reduced government spending is more expansionary, not restrictive, as the Keynesians claim. When the government spends, it uses resources that might otherwise be employed by the private sector. If the government were not bidding in the same market for these resources, they could be obtained by the private sector at lower cost. Lower private production costs push out the aggregate supply curve and reduce prices (or at least, lessen the inflation rate). If the government were not financing such large expenditures, more financing would be available at lower cost to the private sector, thus lowering private production costs, pushing out the aggregate supply curve, and reducing prices.

Tax Collections

LAFFER CURVE
The rationale for supply-side tax cuts is the Laffer Curve, developed by economist, Arthur (Ha! Ha!) Laffer. Dr. Laffer argues that the government can raise the same amount of tax revenues from two different sets of income and corporate profits tax rates. If the tax rate is 0%, tax collections are zero regardless of the level of income. If the tax rate is 100%, tax collections are also zero, because no individual or business is willing to work solely to support the government. In between, as the tax rate rises, tax collections rise. As the tax rate continues to rise, the disutility of work and enterprise sets in and income and profits decline. Since the tax base is declining, tax collections fail. As a result, there is some optimum tax rate at which tax collections are maximized. Above the optimum rate, tax collections decline. Therefore, it pays for government to reduce tax rates to build up the tax base and raise tax collections.

The Composition of Government

The combination of taxes and spending programs is at least as important as the overall level of tax revenues and expenditures. The types of taxes that the government collects and the various programs on which government spends are listed in the prototype of the federal budget, above, at the beginning of this chapter. Supply-siders consider some of the taxes less onerous than other taxes and some of these spending programs more productive than others. They would, thus, rearrange the taxing and spending priorities. For example, supply-siders consider taxes on interest and dividend income onerous, because they stifle capital spending. When these taxes are lowered or removed, the after tax return increases. Therefore, lenders will be disposed to lend more to businesses and entrepreneurs will be disposed to spend more on capital goods. For another example, supply-siders consider many social services programs are considered anti-productive because they impede the work effort and defense programs are considered productive because they ensure a safe and secure political climate for the acquisition of capital and the conduct of trade.

The Regulatory Environment

Regulation is the imposition of restrictions; deregulation is the removal of those restrictions; and reregulation is the changing of the restrictions. Regulation can be price, quantity, social, environmental, product, geographic, etc. Without any government regulation, private markets are left to their own devices to best allocate resources, distribute income, and stabilize economic activity. Without any government regulation, such anarchy breeds market failures — monopoly, externalities, poverty, etc. Government intervention is necessary to correct these market failures; however, in its zeal to redress market failures, government very often exceeds its authority, such that the marginal costs of regulation exceed the marginal benefits from regulation. At that point, government must reduce the restrictions to improve the economic climate. According to supply-siders, overregulation, with its attendant bureaucratic red-tape, can be more damaging to economic activity and stability than underregulation; and, given the increasing amount of regulation over the last 50 years, the time has come to deregulate.

Antitrust Regulation

Antitrust laws are especially designed to break down restrictive monopolies and to keep markets competitive so that prices remain flexible and resources are free to move among competing alternatives.

The Money Supply

Supply-side economists are monetarists in disguise. They believe that the Fed should target the rate of growth of the money supply. However, they tend to go one step further in concluding that its growth rate should be ample. After all, their fiscal program is, in the Keynesian framework, restrictive.

top     Summary

The policy instruments or tools are the means through which the government and its authorized agencies attempt to achieve macroeconomic stability. The fiscal policy tools include changes in government expenditures and tax collections. Tax collections can be modified by changing tax rates, tax bases, and/or tax credit incentives. The use of these tools determines the size of the budget deficit or surplus. The monetary policy tools include reserve requirements, the discount rate, and open market operations. The use of these tools determines interest rates, the size of the money supply and its growth rate. The incomes policy tools include wage and price controls, tax incentive plans, and indexing. The use of these tools determines income shares. The debt management tools include the maturity characteristics of the U.S. government's securities. The use of these tools determines the term structure of interest rates and the yield curve. The supply-side tools include the overall size of the public sector (as measured through its gross budget), the composition of government expenditures, the structure of taxes, and the number and composition of regulations on business. The use of these tools determines the quantity and quality of resources available to the private sector.

top    Readings

Guidelines in Economic Stabilization: A New Consideration, L. Klein and V. Duggal, Wharton Quarterly, VI Summer 1971: 20-24

The Effectiveness of Using The Tax System to Curb Inflationary Collective Bargains: An Analysis of The Wallich-Weintraub Plan, Peter Isard, Journal of Political Economy, LXXXI 1973: 729-40

Incomes Inflation and the Policy Alternatives, A. Okun, The Economists Conference on Inflation: Report, I 1974: 365-75

Using Escalators to Fight Inflation, Milton Friedman, Fortune, XC Jul 1974: 90-97

Selection of a Monetary Aggregate for Economic Stabilization, Leonall C. Andersen, Review (FRBStL), LVlI(9) Sep 1975: 9-15

Indexing and the Capital Markets? William Poole, American Economic Review, LXVI (2) May 1976: 200-4

A New Approach to Control Inflation, Laurence S. Seidman, Challenge, Jul/Aug 1976: 39-43

A Payroll Tax Credit to Restrain Inflation, Laurence S. Seidman, National Tax Journal, XXIX Dec 1976: 398-412

Innovative Policies to Slow Inflation, A. Okun and G. Perry, eds., Brookings Papers on Economic Activity, II 1978

Tax-Based Incomes Policies, Laurence S. Seidman, Brookings Papers on Economic Activity, II 1978: 301-48

Administrative Problems of Tax Based Incomes Policies, Larry Dildine and Emil Sunley, Brookings Papers on Economic Activity, II 1978: 363-89, with Comment, J. Pechman, Brookings Papers on Economic Activity, II 1978: 390-94

New Policies to Fight Inflation: Sources of Skepticism? Albert Rees, Brookings Papers on Economic Activity, II 1978: 453-77

A Wage Increase Permit Plan (WlPP) to Stop Inflation, Abba P. Lerner, Brookings Papers on Economic Activity, II 1978: 491-505

The Federal Reserve and The Government Securities Market, Margaret K. Bedford, Economic Review (FRBKC), Apr 1978: 15-31

Tax-Based Incomes Policy: Technical and Administrative Aspects, Richard E. Slitor, unpublished Federal Reserve Bank paper, 7 Apr 1978

Incomes Policies: NIP, WlPP, and TIP, David Colander, Journal of Post Keynesian Economics, 1(3) Spring 1979: 91-100

The Role of a Tax-Based Incomes Policy, Laurence S. Seidman, American Economic Review, LXIX(2) May 1979: 202-6

Comparing TIP to Wage Subsidies, Donald A. Nichols, American Economic Review, LXlX(2) May 1979: 207-11

Implementation and Design of Taxed-Based Incomes Policies, Richard E. Slitor, American Economic Review. LXIX(2) May 1979: 212-15

Tax Cuts: Who Shoulders the Burden? James Gwartney and Richard Stroup, Economic Review (FRBAtl), Mar 1982: 19-27

On The Adequacy of Policy Instruments and Information When The Meaning of Money is Changing, Donald D. Hester, American Economic Review, LXXII(2) May 1982: 40-44

The Federal Reserve System: Purposes and Functions, Board of Governors of the Federal Reserve System, Washington, DC, 1996: apps. A, B

MZM: A Monetary Aggregate for the 1990s? John B. Carlson and Benjamin D. Keen, Economic Review (FRBClev), 32(2) 2Q96

Where Is All the U.S. Currency Hiding? John B. Carlson and Benjamin D. Keen, Economic Commentary (FRBClev), 15 Apr 1996

Interest Rate Rules for Seasonal and Business Cycles, Charles T. Carlstrom and Timothy S. Fuerst, Economic Commentary (FRBClev). Jul 1996

Competing Currencies: Back to the Future? Ben Craig, Economic Commentary (FRBClev), 15 Oct 1996

Combining Bank Supervision and Monetary Policy, Joseph G. Haubrich, Economic Commentary (FRBClev), Nov 1996

Understanding Open Market Operations, M.A. Akhtar, FRBNY, 1997

Interest Rates and Monetary Policy, Glenn Rudebusch, Economic Letter (FRBSF), 97(18) 13 Jun 1997

U.S. Monetary Policy and Financial Markets, Anne-Marie Meulendyke, FRBNY, 1998

Managing Treasury Flow of Funds, William F. Hummel, Last updated 3 Oct 2000

Are U.S. Reserve Requirements Still Binding? Paul Bennett and Stavros Peristiani, Economic Policy Review (FRBNY), May 2002: 53-68, with Commentary, James A. Clouse, Economic Policy Review (FRBNY), May 2002: 69-71

Interest on Reserves and Monetary Policy, Marvin Goodfriend, Economic Policy Review (FRBNY), May 2002: 77-84

top    Websites

Budget of the United States Government, OMB
The Federal Reserve System In Brief, FRBSF
Repurchase/Match-Sale Transactions, Fedpoint (FRBNY)
Exchange Stabilization Fund (Treasury), Fedpoint (FRBNY)
Federal Funds, Fedpoint (FRBNY)
The Intended Federal Funds Rate, 1990 to present
Discount Window, FRBBOG
The Discount Window, Fedpoint (FRBNY)
The Discount Rate, FRBBOG
Open Market Operations, Fedpoint (FRBNY)
Open Market Operations, FRBBOG
Currency Devaluation/Revaluation, Fedpoint (FRBNY)
Foreign Exchange Intervention, Fedpoint (FRBNY)
Dollars and Cents: Fundamental Facts about U.S. Money, FRBAtl
Treasury Debt Instruments
Credit and Liquidity Programs and the Balance Sheet, FRBBOG
Term Asset-Backed Securities Loan Facility, FRBBOG
Reserve Requirements, FRBBOG
Interest on Required Balances and Excess Balances, FRBBOG
Term Deposit Facility, FRBBOG
Expired Policy Tools, FRBBOG


previoustopnext