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→Open Market Operations (Supply): added an simple example to flesh out how money creation works in practice
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First, and used more commonly than any other method since the 1980s, are '''Open Market Operations''' conducted by the New York Fed under the oversight of the Federal Open Market Committee. Primary dealers keep in contact through a dedicated desk at the NY Fed, and buy Governmental bonds from the fed using TRAPS (Trading Room Automated Processing System), a software used exclusively for these transactions. There are two types, defensive and dynamic. Defensive operations try to stabilize the market in response to some externality. For this reason, they are usually temporary measures like repo or matched sale-purchase agreements. Repo is when the fed buys securities with an understanding that they will be returned at a future data, and matched sale-purchase agreements are just the opposite, the Fed selling with an agreement for future re-acquisition. Dynamic operations, like that of Jerome Powel in March of 2023 to raise interest rates, are when the fed wants to make a change in the market, in this instance to fight inflation. | First, and used more commonly than any other method since the 1980s, are '''Open Market Operations''' conducted by the New York Fed under the oversight of the Federal Open Market Committee. Primary dealers keep in contact through a dedicated desk at the NY Fed, and buy Governmental bonds from the fed using TRAPS (Trading Room Automated Processing System), a software used exclusively for these transactions. There are two types, defensive and dynamic. Defensive operations try to stabilize the market in response to some externality. For this reason, they are usually temporary measures like repo or matched sale-purchase agreements. Repo is when the fed buys securities with an understanding that they will be returned at a future data, and matched sale-purchase agreements are just the opposite, the Fed selling with an agreement for future re-acquisition. Dynamic operations, like that of Jerome Powel in March of 2023 to raise interest rates, are when the fed wants to make a change in the market, in this instance to fight inflation. | ||
For an example of how this '''money creation''' might work, imagine a transaction between the Fed and Wells Fargo. Say the economy is slowing down and the Fed wants to gas it up, they might purchase 100 government securities from Wells Fargo. Wells Fargo will have less government securities (issued at the discretion of the Treasury), and Fed will have more. '''Under the federal reserve system, minimum reserves are set, and Banks are required to keep these reserves (RR) in an account at the Fed. So in return for the government issued securities, the Fed credits the account the Bank has with them. Just writes something on a line. This increases the Banks reserves, increasing the amount they can lend.''' In economese this increases the Monetary Base (and, necessarily, the Money Supply) by 100. If the bank chooses to keep it in currency rather than deposits, then reserves stay the same but the effect on the monetary base is the same. In the case of sales it is just the opposite and the money supply decreases. | |||
In the chart, purchases increase the amount of non-borrowed reserves, shifting the vertical portion of the supply curve right and thereby lowering the federal funds rate, leading to an increase in overall market liquidity. In the second, because the federal funds rate cannot fall below the interest rate paid on reserves, we hit the flat section and there is no effect on federal funds rate | |||
==== Discount Rate (Supply) ==== | ==== Discount Rate (Supply) ==== | ||
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==== Extraordinary Measures (2008) ==== | ==== Extraordinary Measures (2008) ==== | ||
Above are the conventional methods of monetary policy. In some circumstances, they become insufficient. In particular, there is what is known as the '''Zero-Lower Bound Problem'''. Interest rates, for obvious reasons, cannot be negative, so as they approach zero there comes a point where nothing further can be done. If the economy is still unresponsive, the Fed can, as it did in 2008, take extraordinary measures. One method was to '''extend the term of discount loans''', giving banks longer to pay them back. Another was the '''Term Auction Facility''', through which the Fed extended 3.8 trillion in collateralized loans at rates below the discount rate. The auctions were administered by the New York Fed though loans were offered through all twelve of the Federal Reserve Banks. At the same time, the Fed also began to make '''large scale purchases of toxic assets'''. | Above are the conventional methods of monetary policy. In some circumstances, they become insufficient. In particular, there is what is known as the '''Zero-Lower Bound Problem'''. Interest rates, for obvious reasons, cannot (usually) be negative, so as they approach zero there comes a point where nothing further can be done. If the economy is still unresponsive, the Fed can, as it did in 2008, take extraordinary measures. One method was to '''extend the term of discount loans''', giving banks longer to pay them back. Another was the '''Term Auction Facility''', through which the Fed extended 3.8 trillion in collateralized loans at rates below the discount rate. The auctions were administered by the New York Fed though loans were offered through all twelve of the Federal Reserve Banks. At the same time, the Fed also began to make '''large scale purchases of toxic assets'''. | ||
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[[Category:Good Articles]] | [[Category:Good Articles]] | ||