CHAPTER 11 6.

Reduce Loans ⁎ Benefits the owners of a bank by making their R = RR + ER R=total reserves,
General Principles of Bank Management investment safe. RR = r x D RR=required reserves
• Liquidity Management ⁎ Costly to owners of a bank because the R = (r x D) + ER ER=excess reserves
1. Ample Excess Reserves higher the bank capital, the lower the return *Fed sets r < 1 r=required ratio
on equity.
⁎ Choice depends on the state of the economy MB = C + R = C + (r x D) + ER
- Reduction of loans is the most costly way of and levels of confidence.
• Equation reveals the amount of the MB needed
acquiring reserves. • Credit Risk
- Calling in loans antagonizes customers. to support the existing amounts of D, c and ER.
- Screening and Monitoring
- Suppose bank’s required reserves are 10%. - Other banks may only agree to purchase loans ⁎ Screening c={C/D} ⇒ C=c x D, and
- If a bank has ample excess reserves, a deposit at a substantial discount. ⁎ Specialization in lending e={ER/D} ⇒ ER=e x D
outflow does not necessitate changes in other
⁎ Monitoring & enforcement of restrictive
parts of its balance sheet. • Asset Management substituting in the previous equation,
covenants
2. Shorfall in Reserves - Goals:
- Long-term customer relationships. MB = (r x D) + (e x D) + (c x D) = (r + e + c) x D
1. Seek the highest possible returns on loans
- Loan commitments.
and securities. Divide both sides by the term in parentheses,
- Collateral and compensating balances.
2. Reduce risk.
- Credit rationing. 𝟏
3. Have adequate liquidity. D= x MB
• Interest-rate Risk 𝒓+𝒆+𝒄
- Tools: M = D + C and C = c x D
- Reserves are a legal requirement and the 1. Find borrowers who will pay high M = D + (c x D) = (1 + c) x D
shortfall must be eliminated. interest rates and have low possibility
- Excess reserves are insurance against the costs of defaulting. substituting again,
associated with deposit outflows. 2. Purchase securities with high returns and 𝟏+𝒄
3. Borrowing M= x MB
low risk. 𝒓+𝒆+𝒄
3. Lower risk by diversifying. The money multiplier is then,
4. Balance need for liquidity against increased
𝟏+𝒄
returns from less liquid assets. m=
𝒓+𝒆+𝒄
• Liability Management - If bank has more rate-sensitive liabilities than
- Recent phenomenon due to rise of money assets, a rise in interest rates will reduce bank CHAPTER 16
- Cost incurred is the interest rate paid on the center banks. profits and a decline in interest rates will raise Open Market Operations
borrowed funds. - Expansion of overnight loan markets and new bank profits. • Dynamic open market operations.
4. Securities Sale financial instruments (such as negotiable CDs). CHAPTER 15 • Defensive open market operations.
- Checkable deposits have decreased in Control of the Monetary Base • Primary dealers.
importance as source of bank funds. • High-powered money • TRAPS(Trading Room Automated Processing
• Capital Adequacy Management MB = C + R C= currency in circulation System).
- Bank capital helps prevent bank failure. R = total reserves in bank system • Repurchase agreements.
- The amount of capital affects return for the • Matched sale-purchase agreements.
- The cost of selling securities is the brokerage and The Money Multiplier
owners (equity holders) of the bank. Advantages of Open Market Operations
• define money as currency plus checkable
other transaction costs. - Regulatory requirement. • The Fed has complete control over the volume.
deposits: M1.
5. Federal Reserve - Returns to Equity Holders; • Flexible and precise.
• link the money supply (M) to the monetary base
𝒏𝒆𝒕 𝒑𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙 • Easily reversed.
ROA = (MB) and let m be the money multiplier.
𝒂𝒔𝒔𝒆𝒕𝒔 • Quickly implemented.
𝒏𝒆𝒕 𝒑𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙 M = m x MB
ROE = Discount Policy and the Lender of Last Resort
𝒆𝒒𝒖𝒊𝒕𝒚 𝒄𝒂𝒑𝒊𝒕𝒂𝒍 Deriving the Money Multiplier
relationship between ROA and ROE is expressed by • assume that the desired holdings of currency C • Discount window
the Equity Multiplier, and excess reserves ER grow proportionally with • Primary credit: standing lending facility
- Borrowing from the Fed also incurs interest (Lombard facility)
payments based on the discount rate. EM =
𝒂𝒔𝒔𝒆𝒕𝒔 checkable deposits D. Then,
𝒆𝒒𝒖𝒊𝒕𝒚 𝒄𝒂𝒑𝒊𝒕𝒂𝒍 c = {C/D} = currency ratio • Secondary credit
ROE = ROA x EM e = {ER/D} = excess reserves ratio • Seasonal credit
- Safety • Lender of last resort to prevent financial panics
(Creates moral hazard problem)
Advantages and Disadvantages of Discount Policy *bank loan is high because interest is low. Result of Targeting on Nonborrowed Reserves
• Used to perform role of lender of last resort (6) Credit View: Balance Sheet Channel
(Important during the subprime financial crisis of MS↑ ⇒ i↓ ⇒ share↑ ⇒ moral hazard & AS↓ ⇒
2007-2008). lending↑ ⇒ I↑ ⇒ Y↑
• Cannot be controlled by the Fed; the decision *induce stock buying because good image →
maker is the bank. lending is easy.
• Discount facility is used as a backup facility to (7) Credit View: Cash Flow Channel
prevent the federal funds rate from rising too far MS↑ ⇒ i↓ ⇒ cash flow↑ ⇒ moral & AS↓ ⇒
above the target. lending↑ ⇒ I↑ ⇒ Y↑
CHAPTER 17
*when market experience low interest, cash will be
Choosing the Policy Instrument
higher. This is because company pay less for loan,
• Tools
so they will have more cash & induce cash flow.
- Open market operation
- Reserve requirements (8) Credit View: Unanticipated Price Level Channel
- Discount rate MS↑ ⇒ i↓ ⇒ price level↑ ⇒ moral & AS↓ ⇒
• Policy instrument (operating instrument) lending↑ ⇒ I↑ ⇒ Y↑ Change in the interest rate on reserves
- Reserve aggregates. *price↑ will make moral&AS↓ due to extra profit.
- Interest rates. (9) Credit View: Household Liquidity Effects Result of Targeting on the Federal Funds Rate
- May be linked to an intermediate target. MS↑ ⇒ i↓ ⇒ share↑ ⇒ fin wealth↑ ⇒ probability
• Interest-rate and aggregate targets are investment↓ ⇒ C↑ ⇒ Y↑
incompatible (must choose one or the other). *people will spend more to good & services due to
Criteria for Choosing the Policy Instrument increasing financial wealth.
• Observability and Measurability.
• Controllability.
• Predictable effect on Goals.
CHAPTER 26 Open market
The Link Between Monetary Policy and Aggregate
Demand: Monetary Transmission Mechanisms
(1) Traditional Interest-rate Effects
MS↑ ⇒ i↓ ⇒ I↑ ⇒ C↑ ⇒ Y↑
(2) Exchange Rate Effects on Net Exports
How the Federal Reserve’s Operating Procedures
MS↑ ⇒ i↓ ⇒ exchange value↓ ⇒ X↑ ⇒ Y↑
*currency value depreciate, exchange rate’s higher Limit Fluctuations in the Federal Funds Rate
(3) Tobin’s q Theory
MS↑ ⇒ i↓ ⇒ share price↑ ⇒ Tobin’s q↑ ⇒ I↑ ⇒ Y↑
*low interest rate will stimulate share price.
*when i is low, firm will make loan to do business. Change in discount rate
*more people willing to buy stocks.
(4) Wealth Effects
MS↑ ⇒ i↓ ⇒ share↑ ⇒ fin wealth↑ ⇒ I↑ ⇒ Y↑
*higher dividend.
*changes in stock price.
(5) Credit View: Bank Lending Channel
MS↑ ⇒ i↓ ⇒ bank deposit↑ ⇒ bank loan↑ ⇒ I↑
⇒ C↑ ⇒ Y↑
*bank deposit can be high because it comes from
businesses & not only households.