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The Federal Reserve (Fed) defines monetary policy as the actions it
undertakes to influence the availability and cost of money and
credit. Because the expectations of market participants play an
important role in determining prices and growth, monetary policy
can also be defined to include the directives, policies,
statements, and actions of the Fed that influence how the future is
perceived. In addition, the Fed acts as a "lender of last resort"
to the nation's financial system, meaning that it ensures continued
smooth functioning of financial intermediation by providing
financial markets with adequate liquidity. This role has become of
great importance following the onset of the recent financial
crisis. Traditionally, the Fed has three means for achieving its
goals: open market operations involving the purchase and sale of
U.S. Treasury securities, the discount rate charged to banks who
borrow from the Fed, and reserve requirements that governed vault
cash or deposits with the Fed as a proportion of deposits.
Historically, open market operations have been the primary means
for executing monetary policy. Recently, in response to the
financial crisis, direct lending became important once again and
the Fed has created a number of new ways for injecting reserves,
credit, and liquidity into the banking system, as well as making
loans to firms that are not banks. As financial conditions
normalized, direct lending tapered off. Emergency lending programs
have been wound down, with the exception of foreign central bank
liquidity swaps.
The Federal Reserve (Fed) defines monetary policy as the actions it
undertakes to influence the availability and cost of money and
credit. Since the expectations of market participants play an
important role in determining prices and growth, monetary policy
can also be defined to include the directives, policies,
statements, and actions of the Fed that influence how the future is
perceived. In addition, the Fed acts as a "lender of last resort"
to the nation's financial system, meaning that it ensures continued
smooth functioning of financial intermediation by providing
financial markets with adequate liquidity. This role has become of
great importance following the onset of the recent financial
crisis. Traditionally, the Fed has three means for achieving its
goals: open market operations involving the purchase and sale of
U.S. Treasury securities, the discount rate charged to banks who
borrow from the Fed, and reserve requirements that governed vault
cash or deposits with the Fed as a proportion of deposits.
Historically, open market operations have been the primary means
for executing monetary policy. Recently, in response to the
financial crisis, direct lending became important once again and
the Fed has created a number of new ways for injecting reserves,
credit, and liquidity into the banking system, as well as making
loans to firms that are not banks. As financial conditions
normalized, direct lending tapered off. Emergency lending programs
have been wound down, with the exception of foreign central bank
liquidity swaps.
The United States has been free of a national debt for only 2
years, 1834 and 1835. We began our existence as a country in 1790
with a debt of $75 million. It rose to $3.8 trillion in 1997. It
rose to a high of 108.6% of gross domestic product (GDP) at the end
of World War II; declined to a post-World War II low of 23.8% of
GDP in 1974; and, then, rose to another high of 49.5% of GDP in
1993. The major cause of debt accumulation has been war. The United
States has financed the extraordinary expenditures associated with
war by borrowing rather than by raising taxes or printing money.
This pattern was broken by the large budget deficits of the 1980s
and 1990s which caused the national debt to rise substantially as a
fraction of GDP during peacetime. While economists have long
recognized that a national debt imposes an inescapable burden on a
nation, they have debated whether the burden is borne by the
generation who contracts the debt or is shifted forward to future
generations. There has also been some controversy over the nature
of the burden. The current consensus among economists is that the
...
The U.S. trade deficit is equal to net foreign capital inflows.
Because U.S. investment rates exceed U.S. saving rates, the gap
must be financed by foreign borrowing. Net capital inflows have
grown over recent years to a record 6.6% of gross domestic product
(GDP) in 2006. Economists have long argued that the low U.S. saving
rate, which is much lower than most foreign countries, is the
underlying cause of the trade deficit and that policies aimed at
reducing the trade deficit should focus on boosting national
saving. The most straightforward policy would be to reduce the
budget deficit, which directly increases national saving.
The U.S. financial system processes millions of transactions each
day representing daily transfers of trillions of dollars,
securities, and other assets to facilitate purchases and payments.
Concerns had been raised, even prior to the recent financial
crisis, about the vulnerability of the U.S. financial system to
infrastructure failure. These concerns about the "plumbing" of the
financial system were heightened following the market disruptions
of the recent crisis. The financial market infrastructure consists
of the various systems, networks, and technological processes that
are necessary for conducting and completing financial transactions.
Title VIII of the Dodd-Frank Act, P.L. 111-203, the Payment,
Clearing, and Settlement Supervision Act of 2010, introduces the
term "financial market utility" (FMU or utility) for those
multilateral systems that transfer, clear, or settle payments,
securities, or other financial transactions among financial
institutions (FI) or between an FMU and a financial institution.
Utilities and FIs transfer funds and settle accounts with other
financial institutions to facilitate normal day-to-day transactions
occurring in the U.S. economy. Those transfers include payroll and
mortgage payments, foreign currency exchanges, purchases of U.S.
treasury bonds and corporate securities, and derivatives trades.
Further, financial institutions engage in commercial paper and
securities repurchase agreements (repo) markets that contribute to
liquidity in the U.S. economy. In the United States, some of the
key payment, clearing, and settlement (PCS) systems are operated by
the Federal Reserve, and other systems are operated by private
sector organizations. With Title VIII of the Dodd-Frank Act, which
was enacted on July 21, 2010, Congress added a new regulatory
framework for the FMUs and PCS activities (of FIs) designated by
the Financial Stability Oversight Council as systemically
important. On July 18, 2012, the Council voted unanimously to
designate eight FMUs as systemically important. Title VIII expands
the Federal Reserve's role, in coordination with those of other
prudential regulators, in the supervision, examination, and rule
enforcement with respect to those FMUs and PCS activities of
financial institutions. Additionally, FMUs may borrow from the
discount window of the Federal Reserve in certain unusual and
exigent circumstances. Although Title VIII primarily affects the
scope of regulatory powers, certain provisions directly affect a
utility's business operations. For example, Title VIII allows FMUs
to maintain accounts at a Federal Reserve Bank and provides access
to the Fed's discount window in unusual and exigent circumstances.
Related to PCS, Title VII of the Dodd-Frank Act imposes
requirements that will significantly affect the business of
clearinghouses in the over-the-counter (OTC) derivatives (swaps)
market. By requiring clearing of certain swap transactions through
central counterparties (CCPs or clearinghouses), Title VII is
expected to increase the volume of transactions processed by
clearing systems subject to Title VIII. Critics contend that Title
VIII grants too much discretionary authority to the Fed in an area
that they argue was not a source of systemic risk during the recent
financial crisis. S. 3497 seeks to repeal Title VIII of the
Dodd-Frank Act, stripping FSOC of its authority to designate FMUs
as systemically important. This report outlines the changes to the
supervision of key market infrastructure that are embodied in the
Dodd-Frank Act. It is intended to be used as a reference for those
interested in the financial system's "plumbing," and how the
associated systems are currently overseen and regulated.
After years of rapid appreciation, house prices barely rose in the
second quarter of 2007, and many analysts expect price declines in
many markets in the near future. There have already been large
drops in house sales and residential investment (house building).
Given the central role that the housing boom has played in the
current economic expansion, many observers fear that a crash in the
housing market will lead to an economy-wide recession. They are
concerned that a fall in house prices could spill over into a
decline in aggregate spending through four channels. First,
builders could respond to lower prices by reducing residential
investment, an important component of gross domestic product (GDP).
Second, since mortgages are backed by the value of the underlying
house, a fall in prices could feed through to financial
instability. Both of these effects have already been felt, with the
rate of residential investment falling by double digits since
mid-2006, and the entire financial sector undergoing a liquidity
crunch triggered by problems with subprime mortgage-backed
securities in August 2007. Third, a fall in housing prices could
lead to a decline in consumer spending through a negative "wealth
effect." Some economists have argued that when house ...
Although "too big to fail" (TBTF) has been a perennial policy
issue, it was highlighted by the near-collapse of several large
financial firms in 2008. Financial firms are said to be TBTF when
policymakers judge that their failure would cause unacceptable
disruptions to the overall financial system, and they can be TBTF
because of their size or interconnectedness. In addition to
fairness issues, economic theory suggests that expectations that a
firm will not be allowed to fail creates moral hazard-if the
creditors and counterparties of a TBTF firm believe that the
government will protect them from losses, they have less incentive
to monitor the firm's riskiness because they are shielded from the
negative consequences of those risks.
The "Great Recession" and the ensuing weak recovery have led the
Federal Reserve (Fed) to reevaluate its monetary policy strategy.
Since December 2008, overnight interest rates have been near zero;
at this "zero bound," they cannot be lowered further to stimulate
the economy. As a result, the Fed has taken unprecedented policy
steps to try to fulfill its statutory mandate of maximum employment
and price stability. Congress has oversight responsibilities for
ensuring that the Fed's actions are consistent with its mandate.
The Fed has made large-scale asset purchases, popularly referred to
as "quantitative easing" ("QE"), that have increased its balance
sheet from $0.9 trillion in 2007 to $2.9 trillion at the end of
2012. Currently, the Fed is purchasing $40 billion of
mortgage-backed securities (MBS) and $45 billion of Treasury
securities each month; because these purchases follow on two
previous rounds of purchases, they have been referred to as
"quantitative easing three" or "QEIII." Unlike the previous rounds,
the Fed has not announced when QEIII will end or its ultimate size.
The Fed views QE as stimulating the economy primarily through lower
long-term interest rates, which stimulate spending on business
investment, residential investment, and consumer durables. Since QE
began, Treasury yields and mortgage rates have reached their lowest
levels in decades; it is less clear how much QE has affected
private-borrowing rates and interest-sensitive spending. Critics
fear QE's potentially inflationary effects, via growth in the
monetary base. Inflation has remained low to date, but QE is
unprecedented in the United States and the Fed's mooted "exit
strategy" for unwinding QE is untested, so the Fed's ability to
successfully maintain stable prices while unwinding QE cannot be
guaranteed. The Fed has also changed its communication policies
since rates reached the zero bound. From 2011 to 2012, it announced
a specific date for how long it anticipated that the federal funds
rate would be at "exceptionally low levels," and over time
incrementally extended that horizon by two years. In December 2012,
it replaced the time horizon with an unemployment threshold-as long
as inflation remained low, the Fed anticipated that the federal
funds rate would be exceptionally low for at least as long as the
unemployment rate was above 6.5%. The Fed argues that its new
communication policies make its federal funds target more
stimulative. In this view, if financial actors are confident that
short-term rates will be low for an extended period of time, then
longterm rates will be driven down today, thereby stimulating
interest-sensitive spending. Uncertainty about economic projections
hampers the Fed's ability to stick to a preannounced policy path,
and any future backtracking could undermine its credibility. If
unconventional policy were failing because it has undermined the
Fed's credibility, the evidence would be high interest rates, high
inflation expectations, or both; to date, neither has occurred. The
sluggish rate of economic recovery suggests that monetary policy
alone is not powerful enough to return the economy to full
employment quickly after a severe downturn and financial crisis. It
also raises questions about the optimal approach to monetary
policy. When is the best time to return to withdraw unconventional
policies, and in what order? Should unconventional policies only be
used during serious downturns, or also in periods of sluggish
growth? Do unconventional policies have unintended consequences,
such as causing asset bubbles or market distortions? If so, are
legislative changes needed to curb the Fed's use of QE, or would
that undermine the Fed's policy discretion and interfere with
conventional policymaking? Or should the Fed try other proposed
unconventional policy tools to provide further stimulus when
inflation is low and unemployment is high?
China's policy of intervening in currency markets to limit or halt
the appreciation of its currency, the renminbi (RMB), against the
U.S. dollar and other currencies has become an issue of concern for
many in Congress. Critics charge that China's currency policy is
intended to make its exports significantly less expensive, and its
imports more expensive, than would occur if the RMB were a
freely-traded currency. They contend that the RMB is significantly
undervalued against the dollar and that this has been a major
contributor to the large annual U.S. trade deficits with China and
the loss of U.S. jobs in recent years. Several bills have been
introduced the 112th Congress that seek to address the effects of
undervalued currencies (which are largely aimed at China),
including H.R. 639, S. 328, S. 1130, S. 1267, and S. 1619 (which
passed the Senate on October 11, 2011). On the other hand, some
analysts contend that China's industrial policies, its failure to
adequately protect U.S. intellectual property rights, and its
unbalanced economic growth model, pose more serious challenges to
U.S. economic interests than China's currency policy. Some U.S.
business groups have also expressed concern that U.S. currency
legislation could aggravate U.S.- China commercial ties.
Of the ten economic expansions in the post-World War II era, three
have been especially long: 1961-1969, 1982-1990, and 1991-2000.
This study compares these three expansions in areas such as GDP
growth, gross and net investment, growth and productivity of the
labour force, the fiscal position of the federal government, and
inflation. Such a comparison can provide perspective and insight
into a number of perceived problems. Given the current economic
turbulence we are facing, this book will serve as an important tool
in studying the market cycle.
This book examines the implications (both challenges and
opportunities) for the U.S. economy from China's rapid economic
growth and its emergence as a major economic power. It also
describes congressional approaches for dealing with various Chinese
economic policies deemed damaging to various U.S. economic sectors.
China has a policy of pegging its currency (the yuan) to the U.S.
dollar. If the yuan is undervalued against the dollar, there are
likely to be both benefits and costs to the U.S. economy. It would
mean that imported Chinese goods are cheaper than they would be if
the yuan were market determined. This lowers prices for U.S.
consumers and diminishes inflationary pressures. It also lowers
prices for U.S. firms that use imported inputs (such as parts) in
their production, making such firms more competitive. Critics of
China's peg point to the large and growing U.S. trade deficit with
China as evidence that the yuan is undervalued and harmful to the
U.S. economy. The relationship is more complex, for a number of
reasons. First, while China runs a large trade surplus with the
United States, it runs a significant trade deficit with the rest of
the world. Second, an increasing level of Chinese exports are from
foreign invested companies in China that have shifted production
there to take advantage of China's abundant low cost labour. Third,
the deficit masks the fact that China has become one of the fastest
growing markets for U.S. exports. Finally, the trade deficit with
China accounted for 23% of the sum of total U.S. bilateral trade
deficits in 2004, indicating that the overall trade deficit is not
caused by the exchange rate policy of one country, but rather the
shortfall between U.S. saving and investment. This book presents a
coherent examination of the details behind China's currency
policies as they relate to outside factors.
Monetary policy can be defined broadly as any policy relating to
the supply of money. Since the main agency concerned with the
supply of money is the nation's central bank, the Federal Reserve,
monetary policy can also be defined in terms of the directives,
policies, statements, and actions of the Federal Reserve,
particularly those from its Board of Governors that have an effect
on aggregate demand or national spending. The nation's financial
press and markets pay particular attention to the pronouncements of
the chairman of the Board of Governors, the nation's central
banker. The reason for this attention is that monetary policy can
have important effects on aggregate demand and through it on real
Gross Domestic Product (GDP),unemployment, real foreign exchange
rates, real interest rates, the composition of output, etc. It is
paradoxical, however, that these important effects, to the extent
that they occur, are essentially only short-run in nature. Over the
longer run, the major effect of monetary policy is on the rate of
inflation. Thus, while a more rapid rate of money growth may for a
time stimulate the economy leading to a more rapid rate of real GDP
growth and a lower unemployment rate, over the longer run these
changes are undone and the economy is left with a higher rate of
inflation. In some societies where high rates of inflation are
endemic, more rapid rates of money growth fail to exercise any
stimulating effect and are almost immediately translated into
higher rates of inflation. Traditionally, two means have been used
to measure the posture of monetary policy. Since monetary policy
involves the Federal Reserve's contribution to aggregate demand or
money spending, it would be logical to examine the growth rate of
the money supply. A growing money supply is important for the
subsequent growth in money spending or aggregate demand. Giving
empirical content to the abstract concept of "the supply of money"
has not been easy. For the United States, three different
collections of assets have been defined as "money" and labelled M1,
M2,and M3. Unfortunately, over the period 1990-2004 these
aggregates have not been consistently linked to money spending and,
consequently, they are not the major focus of monetary policy.
Rather, the Federal Reserve executes monetary policy by setting a
target for an overnight interest rate called the federal funds
rate. Low or falling rates are usually taken as a sign of monetary
ease; high or rising rates usually indicate monetary tightness.
Changes in the federal funds rates affect primarily short-term
interest rates, and through these changes, money spending. The book
then looks more closely at five economies that have adopted a price
stability goal: New Zealand (which was the first country to adopt
targeting), Canada, the United Kingdom, Sweden, and the Euro area.
One key finding from these case-studies is that, in practice,
central banks tend to operate with greater latitude and more
discretion than some targeting proponents may have envisioned. For
example, central banks still tend to respond to a decline in
economic activity by lowering interest rates, even though strict
attention to the target might not justify it. This is possible
because exceptions to the targets are granted for a variety of
shocks and the definition of inflation being targeted often
excludes price changes due to factors such as food, energy, and
excise taxes. The book concludes with a brief analysis of the
record of inflation targeting in the developing world. It finds
that the improvement in economic performance following the adoption
of inflation targeting is greater in the developing world. Since
developing world countries often experience economic and political
instability.
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