Current Events

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• Current Events
• The FOMC meeting
• This is material we will cover later in the
• course, but given the significance of what is
• going to happen today, it seems reasonable to
• cover this. This material will not be on Exam
• 1.

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• I The Current Economic Situation
• Over the past year, the Federal Reserve Bank has
  been raising its interest rates to attempt to
  slow the economy down from the very rapid growth
  it was experiencing.
• B) These policies were successful in slowing the
  economy down. However, they were probably too
  successful, because now we find ourselves on the
  verge of a recession.

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• II Basics concepts
• The Federal Reserve Bank is the U.S. central
  bank.
• 1) Contrary to its name, it is not technically
  part of the Federal Government, but has a great
  deal of independence. This independence is given
  to them so that they do not carry out policies
  which may influence political elections.

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• 2) The Federal Reserve Bank consists of a main
  office in Washington called the Board of
  Governors and 12 district banks located
  throughout the country. This structure is an
  effort to diffuse power.
• B) The Federal Open Market Committee (FOMC) is
  the policy making body which meets ever 6 weeks
  and happens to be meeting today.
• 1) It consists of 12 people. Seven are the Board
  of Governors based in Washington and the other 5
  are district bank presidents who serve on a
  rotating basis.

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• 2) The seven Board of Governors are fourteen year
  terms and are nominated by the president and
  confirmed by Congress. Since their terms expire
  in odd years, any given president can only
  appoint a few members of the board.
• 3) The district presidents are chosen by the
  district banks which own stock in the bank.
• 4) The New York Federal Reserve Bank President is
  always on the FOMC and has a special role.

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• C) Basics on Banking
• When someone deposits money in a bank, the bank
  does not simply hold it until the depositor comes
  back to withdraw it. Instead they loan it out.
  That is how they make a profit.
• 2) Because banks make a profit by issuing loans
  they prefer to loan everything they have.
  However, rules set up by the central bank
  prohibit them from loaning all of the deposit.
  Instead they must keep part of the deposit on
  hand. This amount is called the reserve.

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• 3) Money consists of anything that can be used
  for transactions purposes. Thus, the loans
  created by banks are a type of money. In fact
  90 of the money supply is created by the
  commercial banking system while only 10 is
  created by the Federal Reserve Bank.
• 4) Since banks make their profits by issuing
  loans, they go right up to their reserve
  requirements. If they fall below the reserve
  requirement on any day, banking regulations
  require that they borrow money overnight.

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• 5) Banks have two places to borrow overnight The
  Federal Funds Market at the Federal Funds Rate,
  and directly from the Federal Reserve Bank at the
  Discount Rate.
• D) The Federal Funds Market
• The Federal Funds Market consists of demanders
  who are banks who have fallen below their reserve
  requirements and suppliers who are banks who are
  above the reserve requirements.

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• The market clearing interest rate in the Federal
  Funds market is called the Federal Funds rate.
• 3) When the Federal Funds rate is high, then it
  is more costly for banks to fall below their
  reserve requirements and they make decide not to
  grant as many loans. In other words, a high
  federal funds rate means that credit is tight.
  This usually means that there is less investment
  going on in the economy.

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• 4) When the FOMC meets, they announce two things
  A Federal Funds Rate target and a Discount Rate
  value.
• 5) They reach the Federal Funds target by using
  Open Market Operations where they buy and sell
  bonds in the open market. This is carried out by
  the President of the New York Federal Reserve
  Bank, hence this is why he is a permanent member
  of the FOMC.

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• 6) If the Fed wants to reduce the Federal Funds
  target they will expand the money supply in the
  overnight loan market by buying bonds in the open
  market. Note, they cannot precisely control the
  Federal Funds rate.
• 7) This will encourage banks to make additional
  loans and thus stimulate the economy.

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• E) The Discount Rate
• The FOMC also controls the discount rate which is
  the second way that banks can satisfy their
  reserve requirements.
• 2) Typically the Discount Rate is ¼ to ½ of a
  percent below the Federal Funds Rate target.
• 3) Banks rarely borrow directly from the Fed
  instead preferring to borrow anonymously in the
  Federal Funds market.

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• III What do we expect today.
• The Fed will make its announcement at 215
  eastern time, 115 local time.
• 2) Most expect an aggressive move of 50 basis
  points in both key rates
• 3) If there is only a 25 basis point move, expect
  a dramatic decline in stocks later this
  afternoon.
• 4) If there is a 50 basis point move, stocks
  should move higher.
• 5) If there is a 75 basis point move, stocks are
  likely to move significantly to the upside.